Why did my fund unexpectedly drop in value

? Posts asking the question, “The market was up but my fund (unexpectedly) is down” are quite frequent on the discussion board, particularly in the latter part of December. The usual answer to this question is that the fund’s value dropped because it paid a distribution.

For international index funds, daily fund returns will at times show discrepancy from their tracking index returns due to a valuation procedure known as fair value pricing. Funds employ fair value pricing to protect shareholders from time-zone arbitrage, where short-term market timers seek to exploit fund share prices that are based on closing prices of foreign securities established some time before the fund calculates its own share price.

Fund net asset values and fund distributions
Mutual funds and exchange-traded funds (ETFs) are required to pay income and realized capital gains to their shareholders at least annually. While some do so quarterly, most do so annually, during the last half of December. Funds gain income because some of the stocks they hold pay dividends. Also, funds may realize capital gains when they liquidate holdings. The funds do not pay taxes, and the law requires that these dividends and capital gains be paid to shareholders so that taxes (if due) are paid. In taxable accounts these payments will be documented during January on a Form 1099-DIV.

If your fund is paying out a dividend and/or capital gains distribution, the net asset value (NAV) of the fund will drop by the per share amount of the distributions on the payment date. The investor's economic position is not changed by the distributions, regardless of whether the distributions are re-invested in the fund or taken in cash.

If your fund has a surprising drop in value, follow these guidelines to see if the fund has made a distribution:


 * Check your online statement. Be aware that the dividend may not be paid until a few days after it is declared.
 * Check the fund’s web site. Dividend dates and estimated amounts are usually posted a few weeks in advance.
 * For Vanguard: Mark your calendar for year-end fund distributions (December 22, 2014)
 * For Fidelity: Fidelity Fund Distributions (December 2014)
 * Check your e-mail. Fund companies routinely send e-mails in advance of paying distributions. Fund holders routinely ignore these e-mails.
 * Check out the fund history at some place like Yahoo! Finance. Such sites show the date and amount of distributions paid. Even data for past years may be useful to you.

If you are invested in a tax-advantaged account with dividends reinvested, none of this really matters, because the distributions are shielded from current taxation. You are likely to be discomfited because you are paying such attention to daily price fluctuations.

In a taxable account, the distribution does matter since it is an involuntary taxable event. You probably should wait until after the distribution to purchase new holdings in the fund.

Fair value pricing and international index funds
After the 2003 mutual fund scandal, the SEC required mutual fund companies to institute fair value pricing for international funds subject to stale pricing and attendant potential time-zone arbitrage trading by market timing investors. The situation arises from the fact that European and Pacific stock markets close many hours before the U.S. markets close. Thus the closing stock prices upon which mutual funds value their net asset value at 4:00 p.m. Eastern Time are hours old. Investors having knowledge of subsequent information strongly suggesting higher or lower prices can place buy or sell orders at the stale net asset price and sell or buy at a profit the next trading day.

While fund distributions will cause a fund to drop in value, the return disparities introduced by fair market pricing can be either positive or negative in relation to the benchmark index return.

Finding fair market pricing adjustments for Vanguard international index funds
Beginning in 2005, each Vanguard international index fund annual report gives annual fund returns that have been skewed by fair value pricing. Although the reports state that the resulting discrepancy is short-lived and is likely to reverse the next day, the precise impact of the fair value adjustment is not disclosed.

While Vanguard does not provide daily fair market pricing data, they do report the adjustment on a quarterly basis on their Institutional Investors site.

To get the information, take the following steps;
 * Go to the Vanguard Institutional Investors site;
 * Under browse, select the Equity link;
 * Select the share classes option;
 * Scroll down the list to international equities tab and open it;
 * Find your desired fund (for example, the Vanguard Pacific Index Fund Admiral Shares) and open the page;
 * Select the performance tab.

The performance tab will provide a table of returns data for the fund, benchmark, and fair value pricing impact. These are reported on a quarterly basis. A drop box allows you to access historical data.

The fund's actual return is calculated by subtracting the fair value pricing impact percentage from the reported fund return. The table below represents the data for the Vanguard Pacific Index Fund Admiral Shares, as of September 30, 2014.