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dumbmoney
Joined: 16 Mar 2008
Posts: 1558
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 Posted: Mon Apr 14, 2008 7:31 am Post subject: "Implicit guarantee" of MM funds and Vanguard |
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This issue has come up in several other threads. Some people claim that money market funds have an "implicit guarantee" of not losing money, because in the past funds that were in danger of "breaking the buck" have been bailed out by the management company.
1. Do you agree that money market funds have an "implicit guarantee"?
2. If Vanguard wanted to bail out a money market fund, where would the money come from? Where should it come from?
3. If a Vanguard money market fund losing money is intolerable, shouldn't the funds buy insurance? |
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Ken Schwartz
Joined: 27 Feb 2007
Posts: 2254
Location: USA
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| Posted: Mon Apr 14, 2008 11:33 am Post subject: Re: "Implicit guarantee" of MM funds and Vanguard |
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| dumbmoney wrote: | | 1. Do you agree that money market funds have an "implicit guarantee"? |
Yes. A fund sponsor would be just about committing corporate suicide if it allowed a money market fund to break the buck. The negative publicity would cause a massive drop in assets under management.
| dumbmoney wrote: | | 2. If Vanguard wanted to bail out a money market fund, where would the money come from? Where should it come from? |
I don't know where it should come from, but ultimately it would have to come from raising expense ratios on all funds a tiny bit. (Possibly, Vanguard would only have to reduce the rate at which expense ratios have been decreasing.) A company like Fidelity has an advantage here, because it can just take the money out of profits. On the other hand, Vanguard's rock bottom expenses allow it to manage its money market funds very conservatively, so it is far less likely to have a problem in the first place.
| dumbmoney wrote: | | 3. If a Vanguard money market fund losing money is intolerable, shouldn't the funds buy insurance? |
Interesting idea. I've only heard of insurance for municipal securities. Of course, you've got to worry about the solvency of the insurer in case of large-scale securities defaults.
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Ken |
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nisiprius
Joined: 26 Jul 2007
Posts: 9258
Location: North America; Western Hemisphere; the Earth; the Solar System; the Universe; the Mind of God
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| Posted: Mon Apr 14, 2008 7:58 pm Post subject: |
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1) I don't like the phrase "implicit guarantee." Seems like a contradiction in terms. A guarantee is only a guarantee if it's explicit.
2) The language of Vanguard's prospectus, and probably most money market funds, certainly sets a very explicit expectation. The exact language is: | Quote: | | The Fund seeks to provide current income while maintaining liquidity and a stable share price of $1. |
Now, the word "seeks" is weaseling, and of course they describe several kinds of risk and conclude | Quote: | | An investment in the Fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Although the Fund seeks to preserve the value of your investment at $1 per share, it is possible to lose money by investing in the Fund. |
3) Last year, there was a good deal of excitement over some funds, notably a GE fund, which were emphatically not money market funds per se, but did have names like "enhanced cash." They gave the impression that they were sorta-kind-like money market funds but earned a very slightly higher rate. The GE fund earned that very slightly higher rate by investing in mortgage-backed securities. The upshot was that the fund did "break the buck," but paid $0.96 on the dollar. The uproar suggests that regardless of prospectus caveats, investors take the $1.00 NAV very seriously indeed.
I repeat that the GE fund wasn't a money market fund. But note that a 4% loss in such a fund, however shocking or infuriating it might be, would hardly be enough to ruin your whole retirement, or anything like that.
4) So, no, I don't think "implicit guarantee" is a good way to phrase it. It's better to say that historically money market funds have been safe, by the nature of their investments you'd expect them to be safe, investors (and advisors and investment-book writers) believe them to be safe... and if it turned out they they weren't, it would rock the foundations of investment world.
But the investment world's foundations get rocked every couple of decades.
The main point is that if such a thing did happen, I'd be stunned if the actual dollar loss to fund holders were more than a few percent.
You can easily lose 90% of your investment in a single stock.
You can easily lose a 30% of your investment in a stock-based mutual fund.
You can easily lose 10% of your investment in a bond fund.
And although it's never happened, based on the GE experience I'm prepared to believe that you could conceivably lose 5% of your investment in a money market fund.
Nevertheless, money market funds are intrinsically safer than bond funds, bond funds are intrinsically safer than stock funds, and stock funds are intrinsically safer than individual stocks.
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Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery. |
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Barry Barnitz
Librarian
Joined: 19 Feb 2007
Posts: 1445
Location: Virginia Beach
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| Posted: Mon Apr 14, 2008 8:54 pm Post subject: Flesh and Blood |
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Hi:
The twenty five to thirty flesh and blood individuals who have asked me for investment advice have all. without exception, held their savings in bank deposit instruments.
I have always advised these individuals (given there low risk tolerance and inexperience) to consider only the Vanguard Treasury Money Fund, with its investment in "full faith and credit " backed treasury bills for money market fund investment.
The cost for such safety, living in a state imposing a state tax, has been quite minimal.
I have drafted a sample post on money funds on a sample, test forum wiki:
Money Markets
regards,
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blb
December Birthday Celebration: Ludwig van Beethoven |
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dumbmoney
Joined: 16 Mar 2008
Posts: 1558
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| Posted: Tue Apr 15, 2008 1:34 am Post subject: |
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| nisiprius wrote: | You can easily lose 90% of your investment in a single stock.
You can easily lose a 30% of your investment in a stock-based mutual fund.
You can easily lose 10% of your investment in a bond fund.
And although it's never happened, based on the GE experience I'm prepared to believe that you could conceivably lose 5% of your investment in a money market fund.
Nevertheless, money market funds are intrinsically safer than bond funds, bond funds are intrinsically safer than stock funds, and stock funds are intrinsically safer than individual stocks. |
Look at what has happened to ultrashort bond funds. They have proven to be riskier than "intrinsically riskier" longer term bond funds, for this reason: when they lose a tiny amount of money, investors flee in a panic, forcing the funds to rapidly liquidate. The liquidation is what causes most of the loss. |
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hudson4351
Joined: 10 Aug 2007
Posts: 170
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| Posted: Thu Aug 07, 2008 12:28 am Post subject: |
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| Quote: |
The Fund seeks to provide current income while maintaining liquidity and a stable share price of $1.
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Is the actual value of the holdings in a money market fund such as VMMXX not supposed to vary, which is why they say they maintain a stable share price of $1?
Or does the value of the underlying holdings actually vary from day to day, and Vanguard puts its own money into the fund as necessary if the value of the underlying holdings would ever cause the share price to drop below $1? Alternately, do they sell off the fund's holdings if they would cause the fund's share price to rise above $1?
Does their holding of the fund's share price at $1 prevent the fund from ever making a captial gains distribution? Are all of the fund's yields treated as interest/dividends?
I have never owned a money market mutual fund before and was always curious as to what was implied by my original quote above, taken from Vanguard's description of the VMMXX fund.
I am just wondering why they would want to hold the value of this fund at $1? |
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mike_slc
Joined: 17 May 2008
Posts: 704
Location: The Big Salty
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| Posted: Thu Aug 07, 2008 2:04 am Post subject: |
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| How could Vanguard make the MM fund whole? I thought the funds owned Vanguard, not the other way around. |
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MossySF
Joined: 19 Apr 2007
Posts: 908
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| Posted: Thu Aug 07, 2008 3:39 am Post subject: |
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| hudson4351 wrote: |
Is the actual value of the holdings in a money market fund such as VMMXX not supposed to vary, which is why they say they maintain a stable share price of $1? |
The fixed income holdings have such short durations that not much can affect the price on the holdings. The price on the open market drops? Big deal -- just keep holding for 2 more weeks and you get paid back in full + interest. For this reason, the underlying value of the holdings don't change much.
The exception is of course a default. So what a MMF usually does is keep the "at-risk" holdings to a percentage small enough to be compensated by the interest earned by the other investments in case of default.
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