Don't Count on Real-Time Pricing in Funds

The proposal has taken a back seat to more pressing measures aimed at reforming the mutual fund industry.
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Of the many proposals for revamping the mutual fund industry, one has conspicuously dropped to the back of the pack -- real-time pricing. And most analysts don't expect it to return to the fore anytime soon.

"The technology is there," says Roy Weitz, a mutual fund advocate and founder of watchdog Web site FundAlarm.com. "But it needs a crisis to get it going."

The current method fund companies use to value their shares is based on stock prices as of the U.S. stock markets' 4 p.m. EDT close. In a real-time pricing world, however, the value of a mutual fund share is based on the prices of the fund's component stocks at the exact time the fund shares are bought or sold.

Real-time pricing theorists say their method is superior to the current standard because it allows investors greater control over their purchases and sales throughout the trading day.

For example, an investor could buy shares in a technology fund with a large position in

Microsoft

(MSFT) - Get Report

at say 2 p.m., when Microsoft is trading at its lowest price. All things being equal, the investor would receive a better price than someone else who bought shares in the fund at the 4 p.m. closing bell, when Microsoft's price was higher.

The vast majority of mutual fund analysts, however, say the industry is very far from being structurally equipped to make that change. Critics also say real-time pricing would defeat the purpose of mutual funds as a vehicle for long-term investing.

"Very few places are set up to do it," says Russ Kinnel, an analyst at Morningstar. "Furthermore, it's too tough for some brokers and banks to get fund orders submitted by the market close right now. Real-time pricing would be asking way too much."

Right now, mutual fund orders must be received by intermediaries like banks and brokers by the 4 p.m. close, but they are often sent to fund firms later in the evening. This practice is widely accepted as long as the fund firms' back offices make sure the orders are time-stamped correctly to show they were made before the 4 p.m. close.

Under a real-time pricing scenario, fund companies would not only need to establish that a purchase order was made at 2 p.m., but they would also have to confirm the exact price for every stock within the fund at 2 p.m. That might not be too difficult a task for a concentrated fund of 10 to 20 stocks, but that's an extremely tall order for fund portfolios that contain hundreds of stocks.

The late-trading scandal put a spotlight on the back-office difficulties already faced by fund companies and their intermediaries. In those cases, late orders were routed through intermediary firms where they were mixed in with legitimate orders placed before the market's close, making the illegal trades tough to spot. Under a real-time pricing structure, the opportunity for mischief is multiplied because the times and prices for individual stock trades within the funds would now be open to manipulation and dispute.

Since real-time pricing is not considered part of the solution to the recent late-trading and market-timing scandal, Chris Wloszczyna, spokesman for the Investment Company Institute, a mutual fund industry trade group, says "it's not going to be on the SEC's radar."

The market-timing issue mostly revolved around frequent trading by short-term investors hoping to exploit fund share prices that lagged behind the value of the underlying securities. Although market timing is not technically illegal, many mutual funds discourage the practice because it can drive up costs and reduce profits available to other shareholders.

A spokesman for the

Securities and Exchange Commission

confirms that real-time pricing is not currently being pursued for the mutual fund industry.

Wloszczyna also says shareholders would wind up paying the cost of switching to real-time pricing, which would mean constant recalculations to funds' net asset value, or the market value of a fund share.

"You would have to hire an army of lawyers, accountants and data collectors to verify those results. So the shareholder would incur those extra costs for a truly undetermined value," says Wloszczyna.

Morningstar's Kinnel is also quick to remind investors on the real-time pricing bandwagon that mutual funds are not supposed to be traded like stocks anyway. They are for long-term investors as opposed to short-term traders. Kinnel suggests investors use exchange-traded funds if they want to buy and sell mutual funds throughout the day.

And as for the fund companies making the change without a push from the SEC or another governing body? Don't count on it.

Says Roy Weitz: "From the funds' perspective, if there was some kind of profit motive, it would have been done already."