Why this strange daily movement in UK smallcap unit trust prices

peter021072

Is anyone familiar with the pricing of smallcap unit trusts and how they relate to their underlying market?  Over the past month there's been some minor divergence between these funds and the smallcap index, however today they have moved particularly violently upwards ~3% without any substantial movement in the underlying indices. It's happened with every fund I'm following, so this can't be explained with a few strange holdings. The budget seems to be the obvious thing, but why?  Perhaps some of this is down to the 12 noon pricing, and they will correct down tomorrow, but this still can't fully explain it

I've pasted the chart of one typical fund against various indices which Morningstar uses for comparison. The blue line is the fund the others are the comparison indices.

graphs co Morning star. 

masonic

Yes, there was an immediate reaction in the AIM index, but this isn't a huge boon for UK smallcaps. Just zoom out for some context.

peter021072

Yes AIM did move more than the others about 1%, and unlike the other smallcap indices AIM has retained some of the increase at the moment, but I doubt if all these trusts were packed with AIM stocks.

It's really the pricing that's baffling me, they don't seem to correspond to any of the midday indices when these funds are priced. Buyers that day would have obtained very poor value considering the 12:00 Small cap pricing on Wed 30th was around 6828.  It then increased around 1% in the afternoon to 6870, that's less than a 1% increase rather than the 3% in the unit trusts.  Now they have dropped back.  It's almost as if the fund managers are putting an artificial increase on the unit trust prices, rather than basing them on the underlying investment prices. Are they allowed to do that?  I wish there was more transparency.

12:00 before the budget is about halfway through the first trading day on the graph below, just before the rapid rise.  At 12:00 the following day Thursday SMX is only about 0.5% up nothing like 3%.  Fledgling is around 0.5% up.

co ADVFN

masonic

peter021072 said:

Yes AIM did move more than the others about 1%, and unlike the other smallcap indices AIM has retained some of the increase at the moment, but I doubt if all these trusts were packed with AIM stocks.

The AIM100 index was at 3483.44 at 1pm and jumped to 3616.74 by 1:30pm, a move of +3.8%. The FTSE250 and iShares MSCI UK Small Cap ETF each went up about 1.5%. Neither seems particularly relevant to a fund with a valuation point at midday though.

The actively managed OIEC you mentioned (Gresham House UK Smaller Co.s) has around 50% of its assets invested in companies too small to be included in the FTSE 250 index, so there are two reasons why it may move more than a smaller companies index... 1) it is actively managed and held proportionately more companies that rose in price on the day; and 2) it targets smaller companies than a typical fund in the sector, or the average market cap of the index.

peter021072 said:

It's almost as if the fund managers are putting an artificial increase on the unit trust prices, rather than basing them on the underlying investment prices. Are they allowed to do that?  I wish there was more transparency.

Yes, it's known as swing-pricing. If there is an excess of buyers, and units need to be created, then the price will include the costs of the net creation of units and purchase of assets. If there is an excess of sellers, and units need to be destroyed, then the price will include the cost of disposals. You cannot usually know in advance whether you will be swimming with the tide or against it, but it pays to do the latter. If a fund has to trade lots of lower liquidity small caps, then its costs will generally be higher than an equivalent large cap fund.

Investment Trusts are a good alternative when investing in lower liquidity assets. With their fixed pool of capital, they do not need to go out and buy or sell shares in their holdings every trading day. They also have live pricing, but other factors like the ability to trade at a discount or premium need to be taken into consideration.

leosayer

masonic said:

peter021072 said:

Yes AIM did move more than the others about 1%, and unlike the other smallcap indices AIM has retained some of the increase at the moment, but I doubt if all these trusts were packed with AIM stocks.

The AIM100 index was at 3483.44 at 1pm and jumped to 3616.74 by 1:30pm, a move of +3.8%. The FTSE250 and iShares MSCI UK Small Cap ETF each went up about 1.5%. Neither seems particularly relevant to a fund with a valuation point at midday though.

The actively managed OIEC you mentioned (Gresham House UK Smaller Co.s) has around 50% of its assets invested in companies too small to be included in the FTSE 250 index, so there are two reasons why it may move more than a smaller companies index... 1) it is actively managed and held proportionately more companies that rose in price on the day; and 2) it targets smaller companies than a typical fund in the sector, or the average market cap of the index.

peter021072 said:

It's almost as if the fund managers are putting an artificial increase on the unit trust prices, rather than basing them on the underlying investment prices. Are they allowed to do that?  I wish there was more transparency.

Yes, it's known as swing-pricing. If there is an excess of buyers, and units need to be created, then the price will include the costs of the net creation of units and purchase of assets. If there is an excess of sellers, and units need to be destroyed, then the price will include the cost of disposals. You cannot usually know in advance whether you will be swimming with the tide or against it, but it pays to do the latter. If a fund has to trade lots of lower liquidity small caps, then its costs will generally be higher than an equivalent large cap fund.

Investment Trusts are a good alternative when investing in lower liquidity assets. With their fixed pool of capital, they do not need to go out and buy or sell shares in their holdings every trading day. They also have live pricing, but other factors like the ability to trade at a discount or premium need to be taken into consideration.

Fantastic explanation.

Fund unit pricing is a little understood and quite complex topic. ETFs create another layer on top of that.

peter021072

masonic said:

peter021072 said:

Yes AIM did move more than the others about 1%, and unlike the other smallcap indices AIM has retained some of the increase at the moment, but I doubt if all these trusts were packed with AIM stocks.

The AIM100 index was at 3483.44 at 1pm and jumped to 3616.74 by 1:30pm, a move of +3.8%. The FTSE250 and iShares MSCI UK Small Cap ETF each went up about 1.5%. Neither seems particularly relevant to a fund with a valuation point at midday though.

The actively managed OIEC you mentioned (Gresham House UK Smaller Co.s) has around 50% of its assets invested in companies too small to be included in the FTSE 250 index, so there are two reasons why it may move more than a smaller companies index... 1) it is actively managed and held proportionately more companies that rose in price on the day; and 2) it targets smaller companies than a typical fund in the sector, or the average market cap of the index.

That's why I've used a graph of the UK Smallcap index throughout the day, so you can compare it at 12:00.  Morningstar use three other indices to track small companies which I've printed in the first graph. I don't think any of the indices are anything to do with the FTSE250.  I'm also assuming Gresham, and the other small company funds use Smallcap, perhaps Fledgling or AIM rather than mid cap 250.  Since the FTSE250 and FTSE Smallcap did much the same thing on Thursday (they went down) that's a moot point anyway for this discussion.

To complicate the graph further Morningstar have altered the index values (red, green and light blue lines) for the Thursday, since I printed the first graph, so two of the indices match up slightly with the funds, although these are still falling far short of the actual prices.  The Red line, Morningstar UK Smallcap index actually moved in the opposite direction (down) like the official FTSE Smallcap and FTSE 250 indices did. So there must be substantial adjustment, which incidentally hasn't corrected down on the Friday to any significant extent.




Original graph below, compare the index values for green and red lines, they have changed

peter021072

masonic said:

peter021072 said:

It's almost as if the fund managers are putting an artificial increase on the unit trust prices, rather than basing them on the underlying investment prices. Are they allowed to do that?  I wish there was more transparency.

Yes, it's known as swing-pricing. If there is an excess of buyers, and units need to be created, then the price will include the costs of the net creation of units and purchase of assets. If there is an excess of sellers, and units need to be destroyed, then the price will include the cost of disposals. You cannot usually know in advance whether you will be swimming with the tide or against it, but it pays to do the latter. If a fund has to trade lots of lower liquidity small caps, then its costs will generally be higher than an equivalent large cap fund.

Investment Trusts are a good alternative when investing in lower liquidity assets. With their fixed pool of capital, they do not need to go out and buy or sell shares in their holdings every trading day. They also have live pricing, but other factors like the ability to trade at a discount or premium need to be taken into consideration.

I suppose by 'costs' you mean when the bid price of buying smaller stocks increases far more than the mid price?  It would be more transparent to know what the price of the fund would be based on the mid price value of all the underlying stocks, so investors can at least see the true cost of trading at a time of volatility.

masonic

peter021072 said:

masonic said:

peter021072 said:

Yes AIM did move more than the others about 1%, and unlike the other smallcap indices AIM has retained some of the increase at the moment, but I doubt if all these trusts were packed with AIM stocks.

The AIM100 index was at 3483.44 at 1pm and jumped to 3616.74 by 1:30pm, a move of +3.8%. The FTSE250 and iShares MSCI UK Small Cap ETF each went up about 1.5%. Neither seems particularly relevant to a fund with a valuation point at midday though.

The actively managed OIEC you mentioned (Gresham House UK Smaller Co.s) has around 50% of its assets invested in companies too small to be included in the FTSE 250 index, so there are two reasons why it may move more than a smaller companies index... 1) it is actively managed and held proportionately more companies that rose in price on the day; and 2) it targets smaller companies than a typical fund in the sector, or the average market cap of the index.

That's why I've used a graph of the UK Smallcap index throughout the day, so you can compare it at 12:00.  Morningstar use three other indices to track small companies which I've printed in the first graph. I don't think any of the indices are anything to do with the FTSE250.  I'm also assuming Gresham, and the other small company funds use Smallcap, perhaps Fledgling or AIM rather than mid cap 250.  Since the FTSE250 and FTSE Smallcap did much the same thing on Thursday (they went down) that's a moot point anyway for this discussion.

It's irrelevant which index they benchmark themselves against. They are active funds and so they do not track the index. For the Gresham fund, all of the top three holdings and the majority of the top 10 holdings are AIM-listed. There are others within the FTSE Smallcap, while market-cap analysis of the fund suggests there are a few FTSE 250 constituents in there as well. However, it seems to be predominantly AIM. FTSE250 to AIM100 will broadly cover the range of market cap this fund operates within (although it includes companies smaller than those in the AIM100). Those are two indices where minute by minute pricing is readily available. Half-hourly or hourly ticks don't give you enough resolution to hope to see what you are looking for.

peter021072 said:
To complicate the graph further Morningstar have altered the index values (red, green and light blue lines) for the Thursday, since I printed the first graph, so two of the indices match up slightly with the funds, although these are still falling far short of the actual prices.  The Red line, Morningstar UK Smallcap index actually moved in the opposite direction (down) like the official FTSE Smallcap and FTSE 250 indices did. So there must be substantial adjustment, which incidentally hasn't corrected down on the Friday to any significant extent.

If you really want to dive into what has happened in detail, you'll need to look beyond the low resolution picture Morningstar paints. Perhaps look at LSE trading data for some of the fund holdings and see if you can see any large buy orders that got a relatively poor price compared with surrounding smaller orders. Look out for indicative spread figures for the top holdings during market hours as quoted by some investment platforms. But you may struggle to find what you are looking for.

peter021072 said:

I suppose by 'costs' you mean when the bid price of buying smaller stocks increases far more than the mid price?  It would be more transparent to know what the price of the fund would be based on the mid price value of all the underlying stocks, so investors can at least see the true cost of trading at a time of volatility.

There is spread on all listed stocks. It is greater for those with smaller trading volumes. A fund may need to buy or sell quite a lot of shares and this can itself move the market for a specific large order. You won't be able to pick out this sort of detail in an index updated on a half-hourly or hourly basis. So if a fund goes out at midday and buys more than a normally traded amount of lots of small illiquid stocks, then when it reports its daily price that will be based upon the actual market price it achieved for the holdings it bought. It is worth remembering that swing-pricing is a mechanism that protects existing investors by making those trading the fund pay the full cost of the units that were created instead of spreading the cost between all investors. Most would consider this a positive thing.

If you want greater transparency, then your only option is to move away from open-ended funds into the world of exchange traded instruments. The only information you will have when trading an OEIC (or even a dual-priced UT) is yesterday's pricing, which is at least 24 hours out of date by the time the fund revalues. Coupled with that, you have to get your order in a couple of hours before the valuation point, so you cannot know the current price of your security, even at the time you trade. You have to find out later that day or the next day.

If it is simply the daily ups and downs of the ride you are dissatisfied with, then I would respectfully suggest you are keeping too close an eye on your investments. It is also worth remembering that the market price of a small company on any given day does not represent a true valuation of that company, so when you add that up across dozens of holdings and see a 3% variance from day to day due to swing pricing, that's just the tip of the iceberg when it comes to the uncertainty of the valuation. If you hold one of these funds for decades, a few percent either way should have very little significance assuming it manages to achieve some growth.

peter021072

AIM stocks might partly explain some of the divergence because they have certain tax advantages which might have been a target in the budget but weren't affected.

wmb194

peter021072 said:

AIM stocks might partly explain some of the divergence because they have certain tax advantages which might have been a target in the budget but weren't affected.

Their IHT advantages have been diminished but not by as much as feared.

masonic

peter021072 said:

AIM stocks might partly explain some of the divergence because they have certain tax advantages which might have been a target in the budget but weren't affected.

But again, that information wouldn't have been known to the market at midday. The market reaction to the budget came at the appropriate time (i.e. over an hour later during the budget speech), and the AIM market was drifting slightly down in the lead-up. Unless the funds in question were slow to get their orders in.