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Pricing and Valuation

Mutual funds are required to determine the price of their shares at least once each business day. Share price (or NAV) is the value of the securities in the fund’s portfolio, minus liabilities, divided by the number of shares outstanding. Some securities are easy to value because market quotations are readily available. For other securities, there may be no readily available market price. In these cases, the fund’s board is required by statute to “fair value” the securities. To help them do this, boards typically delegate the day-to-day fair valuation determinations, while receiving periodic reports and actively overseeing the process.

Under SEC rules, all funds must adopt written policies and procedures that address the circumstances under which securities may be fair valued, and establish criteria for determining how to assign fair values in particular instances. These policies and procedures should be presented in an understandable way, address conflicts of interest, make clear to whom (advisory personnel, pricing services, portfolio managers) responsibility has been delegated, and establish an appropriate oversight role for the board. In addition, the valuation procedures should address, and boards should understand, methodologies for pricing portfolio securities, testing stale prices, use of broker quotes, and overrides of prices supplied by pricing services. There also needs to be flexibility in the policies and procedures to accommodate changes in various economic climates or new and unusual circumstances. Boards should review the policies and procedures at least annually, or more frequently, as needed.

Illiquid Securities

Boards oversee the adviser’s categorization of securities as “liquid” or “illiquid.” The SEC limits the amount of a fund’s assets that may be illiquid and, as a result, directors typically review and approve a fund’s guidelines for illiquid securities. The topic of illiquid securities is closely tied to the issue of valuation because, as noted above, securities without a readily available market price (and illiquid securities often fall into this category) must be “fair valued.”

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