Trading at Stale Prices with Modern Technology: Policy Options for Mutual Funds in the Internet Age

Abstract

Open-end mutual funds usually rely on the closing prices of the assets they hold to compute their net asset value (NAV), a price at which funds stand ready to buy and sell their own shares. Since the underlying assets' closing prices might be hours or even days old, the fund's NAV can be stale. Though mutual funds are typically targeted at long-term (buy and hold) investors, stale prices create profitable trading opportunities in fund shares. Exploiting a stale-price trading strategy is especially lucrative in domestic small-cap or foreign equity funds. The impact from stale price trading is not trivial. Empirical evidence suggests that stale-price traders expropriate about a quarter of a billion dollars annually from buy and hold investors in international funds alone. The current regulatory scheme encourages the use of fair value pricing by funds in response to significant events, which are linked to large market moves. But while regulators focus on significant events, stale price traders are quietly bleeding long-term fund investors a little each day. This Article argues that every day is a significant event in funds where prices are stale and technology makes daily trading quick and easy. Strengthening the current regulatory scheme requires recognizing not only that fair value pricing might be a daily exercise, but that policies imposing costs on trading could help to reduce wealth expropriation made possible by stale prices and modern trading technology.

Keywords: Mutual funds, stale prices, dilution

JEL Classification: G2, K2