Fair-Value Pricing Hits Arbitrageurs

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Byline: Melanie Wold

Arbitrageurs who take advantage of market movements will find it more difficult if investment funds use fair-value pricing when calculating their net asset value (NAV).Investment funds calculate NAV daily using local prices, often before other geographical markets are open or after they are closed. If another market moves substantially, it can create distortions in NAV that arbitrageurs - mainly hedge funds - take advantage of by dipping in and out of the funds. This creates dilution of the fund and can cause losses to investors.

Thomas Aubrey, markets group director at FT Interactive Data (FTID), says arbitrageurs can look at market statistics and predict fund movements with around 75% certainty. He says: "Timezone arbitrage is a really easy way to make a lot of money, at the expense of the buy-and-hold investor."

Because investment funds have retail investors and movements can affect pension funds, regulators in the US and Europe are "sniffing around" to see what can be done to stop arbitrageurs, says Aubrey.

In 2001, the US Securities and Exchange Commission published a letter to the Investment Company Institute, outlining the use of fair-value pricing. The UK's Financial Services Authority has recently issued guidance on dilution, also suggesting fair-value pricing.

FTID is addressing the need for fair value with a pricing service, which it launched in the US last year. It created methodology for pricing securities by anticipating how the market would have moved if time differences did not interrupt trading.

In the US, funds tend to calculate NAV at 4pm Eastern time, says Aubrey. …