Dilution adjustment explained

What we mean by a dilution adjustment and what it means for you.

A dilution adjustment is a change to the share price of a single priced ICVC fund. It is applied by fund management companies simply to protect existing investors from bearing the costs of buying or selling the underlying investments as a result of large inflows into or outflows from a fund.

The use of dilution adjustments is standard industry practice – its use is detailed in the Financial Conduct Authority’s rules – and is applied solely to protect the value of existing investors' holdings and not for creating a profit or avoiding a loss. The dilution adjustment is not retained by the fund manager.

Single and dual-pricing

There are a number of costs incurred when investing and disinvesting. At a high level, funds can be either single or dual-priced. A dilution adjustment is only used with single priced funds.

Dual-priced funds

Dual priced funds have an 'offer' price, the price at which an investor buys shares in a fund, and a 'bid' price – the price at which investors can sell their shares in a fund. The difference between the bid and offer prices is the bid/offer spread of the underlying investments and the costs incurred in buying or selling them.

Single priced funds

Single priced funds are simply bought or sold at the same price – normally the mid-price – which is generally equidistant between the bid price and the offer price.

The fund manager will, however, still buy or sell the underlying investments on a dual-price basis. This means there will be a difference between the price an investor pays to buy shares or receives when selling shares in the fund and the price the fund manager has to pay or receives for the underlying investments.

The single price is flexible and may change on a daily basis; the fund manager may change the price up or down to protect existing investors from the costs associated with buying or selling the underlying investments as other investors join or leave the fund.

When is a dilution adjustment applied?

However, when there are large net inflows into or outflows from a fund, the costs associated with this can reduce – or dilute – the value of the fund for existing shareholders.

In order to mitigate this impact for shareholders and treat them fairly, a dilution adjustment can be applied which reduces this effect on the shareholders remaining in the fund.

When applying a dilution adjustment, the fund is still single priced, but moves to either a bid or an offer based price.

In times of large inflows, the share price is adjusted up to the price the fund manager has to pay for the underlying investments. This means those investors buying shares in the fund are simply paying the same price as the fund manager. This is also the price paid to any shareholders leaving the fund i.e. they receive a higher price than they would have done under mid-market pricing.

At times of large outflows, the share price is adjusted down to equal the price the fund manager receives for any underlying investments. This means those investors selling shares in the fund are simply receiving the same price as the fund manager. This will also be the price paid by those buying shares in the fund i.e. they will buy shares at a lower price than they would have done under mid-market pricing.

What is a dilution levy?

A dilution levy differs from a dilution adjustment in that it is a separate, explicit charge that fund managers can choose to apply to specific client deals to cover any dealing or other costs they may incur when buying or selling shares in the fund. A dilution levy is generally used in the case of an exceptionally large client transaction in relation to the size of the fund.