A hallmark of the $18 trillion mutual-fund industry is that itpromises easy entry and exit for investors. U.S. regulators nowwant new protections to ensure that pledge can be met, due toconcerns that firms have loaded up on hard-to-sell assets.

The five-member Securities and Exchange Commission (SEC) votedunanimously to pass a measure Tuesday that addresses criticismsthat its rules haven't kept pace with the evolution of the fundindustry. The SEC's proposal follows warnings from the FederalReserve and International Monetary Fund (IMF) that some funds couldstruggle to meet investor redemptions during a market rout.

Under the proposal, funds would have to maintain a minimumcushion of cash or cash-like investments that can be sold withinthree days. Funds also could charge investors who pull their moneyon days of elevated withdrawals.

“Changes in the modern asset management industry call on us tonow look anew at liquidity management in funds and propose reformsthat will better protect investors and maintain market integrity,”SEC Chair Mary Jo White said.

Mutual funds, which are held by 53 percent of all U.S.households, already face a legal requirement to return cash toinvestors within seven days. In search of higher returns, manyfixed-income funds have migrated into riskier debt that doesn'ttrade often and could be difficult to sell at fair value during aperiod of market stress.

A key concern is that any problems will be exacerbated when theFed raises interest rates, causing bond prices to plunge andprompting fund investors to run for the exits.

The SEC's plan would force funds, including exchange tradedfunds (ETFs), to adopt liquidity-management plans and classify howlong it would take to convert positions to cash. Funds would haveto hold a minimum amount of cash or cash equivalents, meaning theassets could be sold within three days. A fund's board of directorswould decide what percentage of a portfolio must be easilyliquidated.

Swing Pricing in Mutual Funds

The recommendation also would give mutual funds the ability touse swing pricing, which would permit asset managers to pass ontrading costs to investors who redeem. Under current rules,investors buy and sell shares at a mutual fund's closing price,known as net asset value (NAV).

Under swing pricing, exiting investors would receive a pricethat is slightly lower than a fund's NAV. Some SEC officials thinkthe change could curb the impulse to stampede out of mutual fundswhen asset prices are at risk of tanking.

Current mutual-fund pricing rules harm investors who remain in afund after a sell-off, according to a September 10 report byBarclays Plc.

Investors who sell their shares on days when a lot of cashleaves a fund get an inflated price because the least liquidholdings aren't immediately repriced, Barclays wrote. After a fundestimates the new price for those bonds, the fund's value declines,lowering returns for investors who still own shares, the bank'sanalysts wrote.

Investors also absorb trading costs that a fund incurs when ithas to sell securities to meet redemptions, Barclays wrote.

“The benefit to early redeemers is effectively a tax oninvestors who remain invested through big downturns,” Barclays'analysts wrote.

Copyright 2018 Bloomberg. All rightsreserved. This material may not be published, broadcast, rewritten,or redistributed.