One of the primary issues in financial instability situations, like bank runs, is the privilege that first movers have. A well-designed liquidity transformation method transfers redemption costs to the redeeming investors, thereby mitigating the first-mover advantage.
Swing pricing adjusts the NAV of a fund to reflect the costs associated with redemptions. This adjustment ensures the remaining investors are equally affected by the costs incurred due to others redeeming their shares.
This is why swing pricing is the primary weapon in the management of any type of funds, designed to mitigate the adverse effects of fud-driven large scale redemptions and break the first mover advantage. There are two major variations of swing pricing:
- Liquidation-based: This method activates the fee once the fund's cash reserve is depleted and il/liquid assets need to be liquidated.