LIQUIDITY, MUTUAL FUND FLOWS, AND REFLOW MANAGEMENT, LLC Case Solution And Analysis, HBR Case Study Solution & Analysis of Harvard Case Studies

LIQUIDITY, MUTUAL FUND FLOWS, AND REFLOW MANAGEMENT, LLC Case Solution

Question 3

Allowing the investors to redeem their shares would provide a benefit to the investors, as they would be able to shift their asset allocation to those assets or the securities which offer a safe investing solution during a crisis or an economic downturn. For instance, in the 2008 crisis the investors’ started preferring the risk free securities over the stock market, as they expected the stock prices to fall and the redemption option allowed to sell their stocks and put up their investment in the other securities.

But the redemption creates a negative effect on the existing as well as the outgoing shareholders. It is because the fact that the redemption of shares involves a high cost for the mutual fund. The fund maintains 3% cash on hand and if the redemption level exceeds the cash on hand; then the fund managers would have to sell the existing assets at the discounted prices, which reduces the fund’s value and the returns for the shareholders, as the trading costs of buying and selling in downward trends involve a significant cost structure.

Question 4

Reflow was the brainchild solution by Gordon Getty. As a part of Reflow services; the company bought the shares of the mutual fund for a period of 28 days, in order to provide liquidity for the mutual fund to provide the debt obligations, in case of redemption by the investors. These services were provided over a fee. This option allowed the fund manager to wait before selling their assets in the market at reduced prices, during the volatile periods.

The mutual funds secured the Reflow’s service by bidding through the Dutch Auction System. The funds from the Reflow services were used to pay for the redemption obligations towards the outgoing investors. After the end of 28 days period; the mutual fund had to buy the shares back through excess cash or by selling the funds’ assets.

The major con addressed by the Reflow services, is to help the open-ended mutual fund with liquidity’s provision, in case of redemption by the investors. In normal situation; the open-ended mutual funds maintain a 3% cash on hand, and if the market goes down and the redemption exceeds the cash on hand then the fund managers have to sell the assets at reduced prices by being large trading costs, ultimately reducing the funds’ return towards the investors. Due to Reflow services;the open ended mutual funds can wait during the volatility period, without selling the assets at a reduced priced and without affecting the funds’ returns by bearing massive trading costs.

Question 5

The trading costs of the securities can lead towards the significant returns provided by the portfolios managed by mutual funds. The trading cost is calculated as the change in price between the purchase price and the price at which the buying offer was made. The trading costs involves three main components:

Price Impact

The price impact is considered the largest cost component among the trading costs. It refers to the change in the stock’s price due to trading volume. For instance, if there is a large scale buying volume then the stocks’ prices would increase and if there is a large scale selling volume then the stocks’ prices would decrease.

Brokerage Commission

In order to get the buying and selling executed through a trader; the fund manager has to pay commission to the dealer, which is usually fixed but depends on trading volume.

Bid/Ask Spread

The bid/ask spread refers to the spread between the bid and the prices offered by the market makers.

Among these costs; the brokerage commission is a fixed cost while the price impact and the bid/ask spreads are variable trading costs. The large funds with greater market capitalization trade in larger quantities, due to which they are able to negotiate with the brokers efficiently as they possess strong negotiation powers over the firms with small capitalization. Similarly, the firms with large market capitals are exposed to a greater risk of price impacts and bid/ask spread. It is because the firms with larger market capitals have larger trade volumes and a small change in price leads towards a significant change in the fund’svalue and its returns.

Question 6

Appendix 1 shows that the trading volumes are required to fund the flow issues each month. The trading volume for the year 2008 had increased to a high level i.e. -51.53% in October, -38.74% in November and -14.68% in December. These values are so high as compared to past figures, which clearly shows that the mutual fund would have to either sell the assets or it would have to get the Reflow’s services in order to refund the debt obligations arising from redemption by the investors.

Question 7

As Annette does not want to incur large trading costs related to the price impact, bid/ask spread and the brokerage commission on the trading of securities, to generate flows for the debt obligation during the redemption situation by the investors, so she should take advantage of the Reflow services. Reflow services provide alternative liquidity provisions for the open ended mutual funds. Annette has two options for managing the flow issues, one is to sell the assets at decreased prices and another is to use the Reflow’s services. Through Reflow’s services; the fund will have to bear the fee for Reflow’s services only, but in case of selling the securities; the firm will have to bear massive trading costs and the assets will be sold at decreased prices. Through selling, the fund will lose valuable assets which could be sold in future with higher prices......................

LIQUIDITY, MUTUAL FUND FLOWS, AND REFLOW MANAGEMENT, LLC Case Solution

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