Forward Pricing

What Is Forward Pricing?

Forward pricing is an industry standard for mutual funds developed by the Securities and Exchange Commission (SEC) that requires investment companies to price fund transactions according to the day's end net asset value (NAV), also known as the forward price. Rule 22(c)(1) provides the basis for this pricing and is known as the forward pricing rule. Forward pricing helps to mitigate shareholder dilution and provides for more efficient mutual fund operations.

Understanding Forward Pricing

Forward pricing is the standard methodology for which open-end mutual funds are transacted. Forward pricing primarily refers to open-end mutual funds which are not traded on an exchange with real-time pricing. Open-end mutual funds are bought and sold from the mutual fund company. Investors can buy them through intermediaries such as financial advisors, brokers, and discount brokerage platforms.

Rule 22(c)(1) of the Investment Advisors Act of 1940 requires that mutual funds be transacted at their forward price. Mutual funds price their shares once per day after the close of the market. The closing price is called the net asset value (NAV). The per-share NAV is equal to the total market value of assets minus the mutual fund’s liabilities divided by the number of shares outstanding. All underlying securities are recorded at their daily closing market value.

Investors requesting transactions will trade at the mutual fund’s next forward price. The forward pricing rule requires that transactions be based on forward prices for the greatest efficiency. Thus, forward pricing requires mutual fund accounting to take careful consideration for the timing of fund transactions. Mutual funds transacted during the trading day will receive the end of day NAV as their transaction price. Mutual funds transacted after the market’s close will receive the next day’s forward price. With forward pricing, a mutual fund transaction cannot take place at a previous NAV. Its price can only be based on a value determined after receipt of an order.

Special Considerations

The SEC instituted Rule 22(c)(1) to mitigate the risk of shareholder dilution that can occur from backward pricing methods. The SEC has also added swing pricing mechanisms for daily NAV calculations which went into effect in November 2018. Swing pricing detailed in Section 22(c)(1) under provisions (a)(3) allow mutual fund companies to marginally account for transactions costs of the fund in order to better manage the fund’s liquidity risks. Companies must establish swing pricing policies that are detailed in a fund’s prospectus.