How Safe Is Your Money Market Fund?
In a market that has seen even supposedly super-safe funds lose upwards of 6% in a single day, are even safer-than-super-safe money market funds immune from getting walloped? Gail MarksJarvis at ChicagoTribune.com writes that while companies that run money markets do everything they can insure that investors in their funds won't lose money, it's not impossible that the sub-prime mess could take a toll:
The models used by Wall Street to design the securities have been a flop. As a result, the securities have plunged in value. Some financial firms are laying low, holding onto the sludge, and hoping that if investors calm down the securities will regain some of their value.
Money market funds are allowed to invest in the mortgage-related securities, but only the safest slices -- or traunches -- of them; such as those rated AAA or AA.
Still, in the current environment, even those slices have lost value, and investors are learning that the top AAA rating on the mortgage-related securities is not akin to AAA in corporate bonds."
But don't panic. While money market funds are not backed by the government, the odds of a money market meltdown are slim:
According to federal rules, the securities within money market funds are supposed to mature quickly -- no longer than 13 months for securities, or 90 days on average for all the investments within a fund. Within those constraints, money market funds can also hold 'illiquid securities' -- or securities, like the mortgage-related bonds. 'Illiquid' means the bonds cannot be sold easily. Of course, in today's nervous market, institutions holding the mortgage-related securities can't find willing buyers at decent prices.
By requiring money market funds to keep risky securities at a minimum, and mandating that most securities mature quickly, the funds have had a reliable track record.
The industry prides itself on guaranteeing that funds "don't break a buck." In other words, if you put a dollar into a fund, you can get that dollar out.
Still, money market funds are not insured by the Federal Deposit Insurance Corporation like bank savings accounts are. So investors cannot take them for granted."
Contact Your Congressperson
We here at MAXfunds.com obviously are pretty fond of mutual funds. After all, we've been encouraging readers of the site to invest in them since MAXfunds began way back in 1999 (though with more than a healthy dose of criticism and contrarian opinion). But while we think mutual funds are the best investment choice for just about everybody, they aren't perfect. One of their biggest drawback is the way investors in mutual funds are taxed.
When you invest in a mutual fund, you are essentially handing your money over to somebody else to invest for you. Because you lose direct control over your investments, you also lose control of your tax situation. If a fund manager sells a stock for a profit and has no losses to counter the gain, you are liable to pay a tax on that profit even if you haven't sold any of your shares in the fund. That means in any given year you could be hit with a monster tax bill clear out of left field - even if you didn't sell a single share of the fund.
Chuck Jaffe from Marketwatch reports on a law pending in Congress that would dramatically change how mutual funds are taxed.
The Generate Retirement Ownership Through Long-Term Holding Act of 2007 -- call it the GROWTH Act -- was introduced in June by Rep. Paul Ryan, R-Wis., effectively rehashing a sound proposal that he has put forth several times since 2003. The bill would allow fund investors to defer capital gains taxes on reinvested distributions until the fund is sold, a change that would simplify personal accounting, make fund investing more attractive and that would put funds on a similar tax plane as stocks."
The effect would be to turn every mutual fund portfolios into a kind of junior Roth IRA:
Allowing an investor to save in a fund without paying taxes on distributions indefinitely effectively creates the "lifetime savings account" that so many politicos have kicked around in recent years. For a buy-and-hold investor, it turns a "taxable fund account" into the equivalent of a traditional IRA, without the contribution limits. (Traditional IRAs require payment of taxes only upon withdrawal but allow investors to trade in and out of securities without generating a tax bill; in an ordinary taxable account, every trade is a taxable event.)"
For fund investors, we think this is a no-brainer. If you agree, why not drop your congressperson a line and tell them to get behind it. For many investors it would be a bigger investing tax break than the recent dividend tax cut.
What's Happening?
Yikes! It's a Dow-dropping-subprime-panic-triple A-summer-meltdown. Jim Juback at MSN Money explains the reasons behind the latest Wall Street wipe out in language you don't have to be Ben Bernanke to understand:
How did all this happen? As any good con man will tell you, the success of a con depends on the mark wanting to believe. The victim, in essence, talks himself into getting fleeced.
In this case, the global investment community wanted to believe that Wall Street and other centers of financial engineering could manufacture investment-grade, long-term debt to meet the huge demand of insurance companies, pension funds and central governments for predictable, long-lived and safe interest-paying investments. Because the need for this paper was so great, these marks were willing to suspend belief. They knew in their heads that you can't manufacture investment-grade debt. But in their hearts they wanted to believe. They needed to believe. They had to believe.
Because, you see, it's the only way out for an aging world that's running a huge shortage of the real stuff. So investors were all too willing to buy fake investment-grade paper -- at prices commanded by the real investment-grade stuff -- until finally the con was revealed as assets were marked to market at 50% or less of their assumed value."
So basically it's all old people's fault.
E*Trade Stops Offering HELOCs Below Prime
In another sign that lending standards are tightening fast, starting today E*TRADE Financial Corporation (ETFC) no longer offers home equity lines of credit (HELOC) at rates below Prime regardless of a borrower’s credit rating or equity in the home. This comes just a few days after some less liquid, investment grade mortgage related securities were repriced downward, hurting some safe bond funds.
Previously, somebody with top tier credit and equity in their home could borrow from E*Trade at the Prime rate minus 0.25% and get an additional 0.25% off for automatic payment from certain types of E*Trade accounts.
The Prime rate – currently 8.25% - is what banks charge their most creditworthy customers. It is also the base rate used to set that vast majority of consumer borrowing – everything from car loans to credit cards.
Somewhere in the fog of the real estate bubble lenders decided a first time home buyer less than 10% down and a middling credit score who was buying a house or condo that had doubled in price in less than five years qualifies as their most creditworthy customers.
You can only imagine what the less creditworthy customers look like. Maybe that is why it was recently noted that about one in four subprime mortgages of Countrywide Financial (CFC) were now delinquent.
Cheap and easy credit was a major factor behind post-tech-crash-and-recession economic and stock market strength. The fast money game was already in the ninth inning after the Fed raised short term rates from their ludicrously low levels (a move that leads to Prime rate increases). Lenders (and mortgage backed securities buying investors), realizing home lending may not be as safe as originally modeled (looking at past performance of course), won’t be playing much longer.
At some point there could be some contrarian opportunities to buy mortgage related companies and debt as the pendulum swings the other way and prime mortgage debt with good home equity coverage can yield an investor 8% or more, but we’re there yet.
At least the lines at Home Depot (HD) will get shorter.
Why You Should Worry About Your Bond Funds
Today’s mutual fund investor is offered a broad range of choices covering every imaginable risk level - everything from essentially no-risk money market funds to leveraged sector short funds that can fall 10% or more in a single day.
As long as an investor understands the risks, investing in a risky fund in not inherently any better or worse than investing in a safe fund. With more risk comes more reward.
A risky fund tends to rise faster but fall harder. By researching a fund’s potential upside and downside an investor can make an informed decision whether or not they should invest in that fund.
It might be appropriate for a young person to build a portfolio with risky biotech and micro-cap funds, while a retiree looking for income would invest the majority of their money in lower risk bond funds. Either way, it’s vitally important that an investor can properly gauge a fund’s risk before they invest. Which is why what happened yesterday to the SSgA Yield Plus (SSYPX) is so troubling.
There are two main risks associated with investing in bonds: default risk (the risk a issuer will not make payments) and interest rate risk (the risk interest rates will rise making existing lower rate bonds less valuable). Bond fund managers reduce these risks by owning only investment grade bonds. Low duration bonds have less interest rate sensitivity because of either short maturities or adjustable rates. Investment grade bonds are those deemed very unlikely to default by the big bond rating agencies. The downside of such risk reduction is less upside in boom times for bonds.
The second safest fund category (right after money market funds which have a stable $1.00 fund price) is ultra short investment grade bond funds. People invest in ultra-short investment grade bonds when they don’t want to lose money – a short term place to park cash right before they are going to make a down payment on a house or before college tuition is due.
But on August 6th, 2007 SSgA Yield Plus, an ultra short bond fund holding investment grade bonds, fell a whopping 3.82%. This continues a fall that started on July 10th and has now taken this formally steady-as-she-goes fund down a sharp 6%.
Previous to this SSgA Yield Plus had been one of the top five lowest risk funds in the entire fund business over the last five years – out of a universe of nearly 7000 portfolios. We’ve used this fund ourselves as a money market alternative in both our MAXadvisor Powerfund Portfolios and our private management accounts.
We won’t know exactly what happened until one of the three fund managers returns our calls, but the fund company has confirmed it was not the result of a one-time distribution to clear the portfolio of capital gains. To quote one representative, it was “probably the way the market played today”.
Reviewing the portfolio shows the likely suspect: the entire portfolio is mortgage related securities. The problem is the mountains of mortgage related debt has now reached beyond the world of subprime, beyond the world of leveraged hedge funds, beyond the world of high risk mortgage lenders. It has landed squarely in one of the safest mutual funds in the business, and could have major ramifications for the entire stock, bond, and housing market as investors reallocate their money.
See Also:
Backdoor Men
Some fund managers are the financial equivalent of rock stars - investing idols that pack their famous funds like Springsteen fills Giant Stadium. But as anyone who's ever been stuck in the nosebleeds when attending a concert at a mega-arena can tell you, sometimes smaller is better. Same goes with mutual funds. Rob Wherry at Smartmoney
points out that investors can get more intimate access to some of the biggest names in fund management by investing in their lesser-known offerings:
Popular funds can swell in size so much that it impacts their performance or they can close their doors to new money, leaving eager investors out in the cold. In those cases, it pays to look at what we call a "backdoor" investment. Run by the same manager, these under-the-radar funds have the potential to be just as lucrative as their better-known brethren — maybe even more so.
The thesis behind investing in backdoor funds boils down to this: Bigger isn't always better. Funds that experience big inflows of cash may find it difficult to buy and sell stocks without artificially driving the share price higher or lower. And managers who suddenly have some cash to spend might be tempted to invest in stocks that they lack conviction about. Smaller, more nimble funds, however, can leave a manager unfettered to invest in only his best ideas."
'Backdoor' funds mentioned in the article:
Bill Miller
Famous For: Legg Mason Value Trust (LMVTX)
Not So Famous For: Legg Mason Opportunity (LMOPX)
Chris Davis and Ken Feinberg
Famous For: Davis NY Venture (NYVTX)
Not So Famous For: Clipper (CFIMX)
Primecap Team
Famous For: Vanguard Primecap (VPMCX)
Not So Famous For: Primecap Odyssey Growth (POGRX)
There are some other examples of smaller funds run by the same manager as a more famous big fund. Bond kingpin Bill Gross of PIMCO Total Return (PTTAX) fame manages Harbor Bond (HABDX), a cheap no-load fund. The closed John Hancock Classic Value (PZFVX) can essentially be had in a slightly different and cheaper versions called Harbor Global Value (HAGVX) - though watch out for the big financial stocks allocations in these and many value funds. Neuberger Berman International Large Cap (NILTX) is similar to International (NBISX). There are some examples of funds with loads or funds for advisors that are run by famous big fund managers, like Fidelity Advisor New Insights (FNIAX) a retool of Fidelity Contrafund (FCNTX).
We own Harbor Bond and Primecap Odyssey Growth in some of our Powerfund Portfolios.
MAXadvisor Powerfund Portfolios Update
Note to subscribers of the MAXadvisor Powerfund Portfolios: August's feature article has been posted.
Last week's 585 point drop in the Dow was the worst in five years. What does the market's recent volatility mean for MAXadvisor Powerfund Portfolio investors? Subscribers click here to find out.
The MAXadvisor Powerfund Portfolios is a collection of seven model mutual fund portfolios ranging in risk from very safe to quite aggressive. Each portfolio is made up of a group of terrific, no-load, low-cost mutual funds that are carefully chosen to work together to lower volatility and increase returns. You can learn more about the MAXadvisor Powerfund Portfolios (and sign up for a free trial if you like what you see) by clicking here.
Janus Back In The Game
Just a year or so after we slammed Janus in 2000 as being a fund family to avoid, investors started to withdraw money from the formerly hot fund family. Those redemptions accelerated as Janus' Go-Go growth funds tanked and the run for the exits really kicked in to overdrive when it became known that Janus was tainted in the fund timing scandal.
Apparently Janus just had their first quarter with net new money into Janus-managed funds in six years. While it’s no longer the $10 billion-a-month and up Janus of yesteryear, at least they are back in the game:
Janus reported on Thursday its core funds attracted $1.5 billion in long-term net inflows in the second-quarter, the first quarterly net inflows since 2001. It also posted a 57 percent jump in second-quarter profit, beating analysts' expectations.
Janus, which is focused on the 'growth' style of investing, started to see outflows from its funds when the tech bubble burst in 2000-01 and 'growth' style went out of favor.
The outflows worsened when Janus was caught up in the industry-wide mutual fund trading scandal of 2003-04, leading to a change in management."
These days there are three fund families with around a trillion or so in assets – Fidelity, Vanguard, and American Funds. Fortunately for Janus, strong markets and solid fund performance has carried them back to just under $200 billion. For comparison, Dodge and Cox has almost this much money in just four funds, and Janus had over $300 billion before the fall.
We’ve actually been recommending a few Janus funds in recent years, and list quite a few in our quarterly favorite fund report (free for subscribers of the MAXadvisor Powerfund Portfolios).
Homes Sink Stocks
Yikes! Lately it seems like it takes something along the line of a big drop in the Chinese market or an exotic macro problem to make the market fall fast and furious. Not this time.
Stocks plummeted on Thursday, with the Dow industrials tumbling more than 300 points, on signs of further weakness in the housing market and deteriorating conditions for corporate buyouts....
...The daily drumbeat of bad news on housing on Thursday came from two of the largest home builders, as D.R. Horton Inc and Beazer Homes posted quarterly losses.
Financial shares took a beating on growing evidence that problems in the subprime mortgage market are spreading, making financing the corporate buyouts that drove the market's spring rally more difficult."
This drop was all about the American dream - your house. Apparently all those billions of dollars in loans to people with no money down and questionable finances wasn't such a good idea after all. What will turn a bad situation into a near crisis is the fact that the homes backing up these loans aren't worth anywhere near the housing boom peak.
This past week marked the point where even the economic optimists realized this problem isn't just about subprime loans, and it probably won't stay neatly contained in the housing sector.
It's Not All Sub-Prime's Fault
Sure, the sub-prime mortgage mess played a big part in this week's wild market gyrations, but it wasn't the only factor. Charley Blaine at MSN Money says there's plenty of blame to go around, and points the finger at hedge funds, quant models, even the securities and exchange commission.
LINK