Forward Pricing Research to Strengthen InvestmentDecisions

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Forward pricing research helps to take the mystery out of open-ended mutual fund pricing. With mutual fund prices, your always looking backward. You don't know your purchase price until the next day. Forward pricing research gives you an upper hand to help make better investment decisions about the next NAV.

How Forward Pricing Is Calculated

Forward pricing is used in pricing calculations of unit investment trusts (UITs) and open-ended mutual funds. This article will reference open-ended mutual funds, but similar calculations and analogies apply to UITs.

Before defining forward pricing, it's important to understand how open-ended mutual fund prices are calculated. The price of an (open-ended) mutual fund is actually the price from the previous day and in some cases the previous two days ago. The price is determined by subtracting liabilities from the net asset then dividing by the outstanding shares.

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Mutual Fund Market Scenari

During market hours, the price of a mutual fund will remain static. This is in contrast to stocks, whose prices fluctuate all day long. The reason stocks fluctuate throughout the trading day is because of constant price discovery of the stock's price by traders. For each buys and sell, the stock's price changes.

When an investor buys a mutual fund during market hours, they see the previous day's price. This doesn't mean the investor is getting an old price. However, they won'tknow the actual price until the next day. Once markets close, the fund manager will calculate all trades for the day and determine the updated NAV. The updated NAV is made available on the following day. This is called forward pricing.

Forward pricing isn't something created by a brokerage house or even a mutual fund company. It's been around for a while. In fact, it comes from Rule 22(c)(1) of the Investment Advisors Act of 1940. This rule required mutual funds to forward price. Per the rule, at the close of market, mutual funds calculate their price as describe above. This price is also called the NAV.

There are methods that can extract value out of a fund's static price during the trading day. This is the domain of forward pricing analysis.

Forward Pricing Analysis

Forward pricing may seem like a shot in the dark. Investors purchase a mutual fund without even knowing the current price. While the current price may not be known, estimates can be determined through forward pricing analysis. The goal of forward pricing analysis is to provide an estimate that is in the same direction of the next day's NAV and as close to the NAV as possible.

Analysis of Underlying Assets

Mutual funds are made up of various stocks and other asset classes, which can include bonds and money market funds. The underlying assets fluctuate throughout the trading day. By tracking and analyzing these assets, an investor can determine the mutual fund's direction. If the underlying assets perform well during the day, the mutual fund is likely to have an up day. It's just the opposite if the assets perform poorly. This type of analysis can provide investors some confidence in the next NAV.

If the underlying assets are diverse and uncorrelated, estimating the next NAV becomes more difficult but not impossible.

End of Day Pricing

Another approach is closely related to end of day pricing. Let's nalysis of underlying assets, you believe the mutual fund price will be up. The problem is that the trading day hasn't completed. The fund's price will only be known after the market closes.

To take advantage of the influence, underlying assets can have on a fund, buying closer to market close means the majority of orders have been filled. Investors buying the fund near the close have a higher probability of seeing their analysis reflected in the next day's NAV (forward price).Investors have to be careful with this technique. Markets could begin dropping in the last 10 or 15 minutes. If an investor bought the fund just before any market drop, the price they receive would probably be much lower than anticipated.

Forward Pricing Analysis Based on the Next NAV

Forward pricing analysis is a complex process. Analyzing historical pricing of underlying assets and the parent fund requires an extensive amount of data and modeling. Buying quality data feeds, software and hiring the right experts is not only expensive but time-consuming.



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