Beginning Day 1 Day 2 by Investors $50 million $45 million $60 million $49.09 million 5 million 5 million 6.11 million 5 million $10/share $9/share $9.82/share $9.82/share $911,110 $911,110 Total assets Number of fund shares Net asset value Profit taken by investors Loss to long-term investors On Day 2, the Asian market rebounds to equal to the original level before Day 1. The market closes on Day 2 at this level. The valuation of the securities in the fund increases and offsets the losses from the previous day. The end result is that investors who bought fund shares on Day 1 redeem their shares on Day 2 [and] have a profit of $911,110, which reflects their purchase of undervalued shares at $9 per share on Day 1. This profit is at the expense of long term shareholders, whose share value is reduced by $0.18 per share. This $0.18 represents profit taken by the short term redeeming investors. In the United States, the Securities and Exchange Commission (SEC) has warned fund firms that relying on stale securities prices can lead to misleading fund prices.11 Furthermore, it appears that a growing number of investors are taking advantage of the price differences between local market closes and the time funds' NAVs get calculated. To avoid these activities, and therefore to protect the existing mutual fund investors, the funds' holdings need to be priced at fair values as per the time the NAV gets calculated, at prices/values that would likely prevail if the local markets indeed were open at this same time. The SEC notes: If a fund determines that a significant event has occurred after the foreign market has closed, but before the NAV calculation, then the closing price for that security would be considered a "not readily available" market quotation, and the fund must value the security pursuant to a fair value pricing methodology.12 There are various techniques and models that can be set up by fund firms to monitor for such significant events. For example, factor models as described in Chapter 20 might also be used as a tool for the generation of fair value prices. We will not get into the details of valuing with factor models at this point; however, it is fair to highlight that a dedicated and independent valuation oversight group is best placed to organize and coordinate these aspects of mutual fund pricing. "SEC letter 2001. 12Ibid.