Experts Only
Vanguard Tries To Ruin Your Investing Tax Break
You can count on mutual fund companies to try to squash any product they think is a competitive threat to their multi-trillion-dollar-in-assets cash machine.
The latest attack on mutual fund dominance is from the relatively unknown exchange traded notes (ETN). These ETF-esque securities are essentially exchange traded derivative contracts. The main force behind ETNs is Barclays iPath® Currency Exchange Traded Notes. With their popular iShares lineup, Barclays is already a big player in ordinary exchange traded funds (ETFs). So far the offerings are mostly focused on commodities and currencies. Still, according to an article on Bloomberg.com today, Vanguard is already trying to nip notes in the bud:
Barclays Plc introduced a new product that put a scare into Vanguard Group Inc. and the rest of the $13 trillion U.S. mutual-fund industry. Now Congress and the Treasury Department are coming to the funds' aid.
The security, called an exchange-traded note, allows individual investors to buy a type of forward contract linked to commodities and assets ranging from oil to currencies to foreign stock indexes. It has lower fees than mutual funds, is less regulated and, for now, lets holders defer taxable income indefinitely.
While less than $10 billion of the notes have been issued so far, mutual-fund companies see the potential for the new instruments to catch on in a big way with investors. The notes are 'derivatives for the masses,' said Alex Gelinas, a tax lawyer at Sidley Austin LLP in New York. For the mutual funds, reining them in is 'the issue of the year.'
The funds argue that the way the notes are handled for tax purposes puts their products at a disadvantage. The industry's trade group wants the government to either scrap the notes' favorable tax treatment or extend it to them too....In response, the Investment Company Institute [ICI], the trade association representing Vanguard and other funds, sent letters to Congress and Treasury calling the tax advantages of exchange- traded notes 'unwarranted, unintended and unfair.'
It got results. The Treasury Department in December said the interest income generated by currency-related notes can't be deferred because they are debt instruments. It may rule on other types of notes this year."
This is not the the first time funds acted to protect their best interests. In recent years fund companies were concerned people would buy professionally managed stock baskets without the inefficiencies, regulations, and costs of the old fashioned mutual fund structure, so they sicked their trade group, the Investment Company Institute, on small upstarts offering these services. Fortunately for fund companies, the idea never gelled with consumers as similar exchange traded funds became popular.
Big Mutual Fund To Buy Merrill Stock At Discount
Today Merrill Lynch (MER) announced they would be selling stock in a private placement to two big investors, Singapore based investment firm Temasek Holdings and famed fund managers Davis Selected Advisors. Davis manages – among others - $50 billion in assets Davis NY Venture Fund (NYVTX) and is one of the most famous mutual fund companies in the business. In the private stock offering, Temasek will get up to $5 billion in Merrill stock, Davis up to $1.2 billion.
Merrill Lynch (NYSE: MER) today announced it has enhanced its capital position by reaching agreements to raise up to $6.2 billion of newly issued common stock in a private placement with Temasek Holdings and Davis Selected Advisors. Merrill Lynch expects these transactions to close by mid-January 2008.
'One of my first priorities at Merrill Lynch was to strengthen the firm’s balance sheet, and today we have made great progress towards that by bolstering our capital position through these investments and our announced sale of Merrill Lynch Capital,' said John A. Thain, chairman and CEO of Merrill Lynch. 'The benefits of these transactions are not limited to strengthening our financial position…'"
The real benefit is the investment bank needs to raise capital to offset mega-billions in losses related to overly enthusiastic wheeling and dealing in the U.S. mortgage market. ...read the rest of this article»
Bill Gross On Today’s Muni Bond Crash
Municipal bonds – which had been a model of stability and safety in investing - started sliding on February 12th. This was the day Money Magazine posted “Munis: The new power portfolio” and just days after Investor’s Business Daily penned, “Munis A Safe Haven While Bear Rampages”.
Yesterday, this slide turned into an avalanche. Many conservative municipal bonds funds fell between 1% and 2% and some leveraged closed-end municipal bond funds fell over 3%. Today promises to be worse than yesterday - troubling news because investors have been encouraged to buy municipal bonds recently to earn about 1% more after tax than safe treasuries. These investors have lost about 5% in the last couple of weeks in ordinary long term muni bond funds, and could be down in the double digits within a few days – to say nothing of the sixty billion or so in leveraged closed-end muni bond funds.
Bond kingpin Bill Gross or PIMCO fame appeared on the FOX Business Network’s “Cavuto” yesterday evening (in the segment after the one in which I appeared). He discussed yesterday’s wipeout in the municipal bond market and forecast that the real bloodbath would be today and perhaps Monday. Gross also predicted major buying opportunities in the next few days in munis:
Gross: There’s significant unwinds in terms of leveraged structures and the municipal market is in shambles. But it doesn’t mean that the credits themselves are not credit-worthy. And so if you can buy California at 5.5% to 6%, what an attractive value. Non taxable to the California holder. State of New York the same way.
These are values that probably won’t come around for another generation but they’re here at the moment. Yes, they’re risky because their prices are moving at the moment down. But they’re not uncreditworthy….
Cavuto: When do you start investing?
Gross: I think you start tomorrow. There’s 100s of municipal closed-end funds. Nuveen’s got some. Blackrock’s got some. PIMCO’s got some. They’re all out there. Tomorrow my forecast: They’re going to be hit hard.
Cavuto: Hit hard, responding to what?
Gross:Responding to these liquidations that are happening as we speak. Tomorrow will be a nasty day for the municipal market. For somebody who is willing to step in into a credit-worthy double A single A type of quality instrument that’s not going to default – cross your fingers – with no guarantees.
These values tomorrow and Monday and Tuesday of next week are going to be enormous."
What Bill Gross is talking about is highly leveraged hedge funds that have been buying up muni bonds and probably shorting treasury bonds.
The logic behind the trade is based on what many financial experts have been telling investors for the past few months: that municipal bond yields are historically high relative to treasury bonds – which is a good deal when compared to taxable treasuries for higher tax bracket investors.
For speculators it was a rationale to gamble. This yield gap between treasuries and munis should eventually converge, or so they thought, so shorting treasury bonds (which would make money if yields went up) and buying municipal bonds (which would make money if municipal bond yields went down) could make money with minimal risk because there is virtually no default rate on municipal bonds and no default rate on government bonds. General interest rate swings would not matter because both treasury bonds and muni bonds would move up or down together (assuming similar duration or interest rate sensitivity). The absolute ONLY risk was if municipal bonds yields went up while treasury yields went down…but why would that happen from already historically wide yield spreads between the two?
Well guess what happened yesterday? Municipal bond fund Vanguard Long-Term Tax-Exempt (VWLTX) was DOWN 1.21% (the fourth worst one-day drop in over a decade) while taxable government bond fund Vanguard Long-Term U.S. Treasury (VUSTX) was UP 1.49%! Now imagine being long munis and short treasuries with say, five times leverage. Doh!
We could have sworn we saw Bill Gross smirk at the trouble now facing the brilliant hedge fund managers. Watch the video closely. For those looking to follow Bill Gross’s lead and buy after the drop, consider unleveraged muni bond funds, like open end Vanguard funds, or closed-end funds that do not leverage, like Nuveen Municipal Value Fund (NUV).