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Legg Mason undone by money funds Thursday, October 30, 2008

Image via WikipediaHaving pumped $2bn into their money funds within the last 12 months, Legg Mason's share price fell 78% over the same period and in the last quarter its' assets under management have fallen by a further 9% to $842bn.

Aside from money market fund troubles, their former star equity chief Bill Miller who outperformed the market for 15 years from 1991 has seen big reversals in the last few years in his main fund, "Legg Mason Value Trust". Between Jan-Jun 2008 it fell by over 28% and its' 10 year performance to Jun 2008 was lower than the S&P500.

Legg Mason operates funds under a range of brands operated by semi-autonomous fund management subsidiaries that tend to specialise in particular asset classes e.g. Western focusses on fixed income.

The Legg Mason sales and distribution teams will have a considerable uphill struggle to maintain existing business, let alone secure new wins. Their saving grace may be their ability to push product from other brands in their stable that have performed better and which have not been "tainted" with the current problems.

Labels: Bill Miller, Legg Mason, Money fund, money funds

posted by John Wilson @ 4:01 PM Permanent Link ,

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Morgan Stanley injects $23bn into Money Funds Wednesday, October 29, 2008

Despite the US Government underwriting US domiciled money funds, Morgan Stanley had to inject $23bn cash into its money funds in September by buying securities such as US Treasuries to cover net redemptions on the funds which totalling $46bn, which is almost a third of the $134bn in such funds.

Morgan Stanley was able to refinance the purchases through a combination of depositing the assets with the Federal Reserve and via sales in the open market.

This action was to avoid the funds "breaking the buck", given the wave of redemptions which would have required liquidation of assets held by the funds in a climate of volatile prices.

I anticipate redemption levels will have been greatly reduced in October with the introduction of the Government guarantee that offers unlimited protection to investors in funds that have subscribed to the scheme. However, I also believe firms will still top-up funds to avoid breaking the buck, despite the scheme, given the reputational harm that would result from having to call on the guarantee scheme.

Presently, the regulatory capital requirement for fund management firms tends to be relatively low. The actions of firms in topping up funds may well prompt a review of whether their capital base is adequate to meet such reputational commitments, regardless of the actual legal wording that firms have no legal obligations to funds.

Labels: Federal Reserve, Money fund, money funds, Morgan Stanley

posted by John Wilson @ 9:04 AM Permanent Link ,

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US Treasury listen to the Banks re Money Funds Wednesday, October 01, 2008

Image via WikipediaWhen the scheme to underwrite money market funds was mooted by the US Treasury a few weeks ago with the aim of dissuading investors from making panic withdrawals, I commented here how the banks were understandably annoyed since it put them at a considerable competitive disadvantage.

The details of the scheme which finally aired on Monday had addressed these concerns in a number of ways

temporary scheme only lasting 3 months, albeit that will undoutedly be extended if current circumstances prevail
only covers investments made up to 19 September i.e. investors who fled/flee to "safety" after this date are not protected
Sliding scale fee charged to a fund based on how far below the "buck" the fund is valued at, with lowest rate being 1 basis point [0.01%]

The scheme does provide unlimited protection, unlike for bank deposits which is capped at $100k. It also covers all investors including foreign and institutional ones.

The Treasury payouts will be triggered if a participating fund sees its net asset value fall below $0.995 a share but the fund must be liquidated within 30 days. Investors will receive their capital in full.

It is almost certain that every fund will seek to join the scheme - not because they have to or have problems, but because they need to preserve investor confidence and will not want to cause investors concern by not joining.

Labels: Money fund, money funds, Money market

posted by John Wilson @ 8:31 AM Permanent Link ,

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AIG break the buck on their money fund Friday, September 26, 2008

AIG Life (UK), part of the US insurance group rescued by the US Government, has advised investors in its Premier Bond enhanced money market fund that it will wind-up the fund in mid December and that investors should not expect to receive all of their capital back. The $5.8bn fund is already closed to redemptions after facing a deluge of withdrawal requests it couldn't meet.

Similar to other enhanced funds, the AIG had a heavy weighting in illiquid paper in order to generate higher returns. Illiquidity and depressed prices mean the fund will suffer losses by selling early rather than holding the paper to maturity.

More on this here and here.

The fund had been popular because AIG offered a rate which was 50 to 70 basis points better than deposits offered by rival providers. It did this through a wrapper which meant that tax on the interest payments could be avoided.

This fund almost certainly falls outside of the US announced scheme to underwrite money funds as this was not offered by one of AIG's US entities.

Labels: aig, American International Group, Money fund, money funds

posted by John Wilson @ 2:03 PM Permanent Link ,

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US Cavalry rides to the rescue of Money Market funds Saturday, September 20, 2008

Image via WikipediaTiming is everything - no sooner had I written about the fallacy surrounding money market funds breaking the buck and the need for regulators to either require fund manager to set aside capital to cover their implicit guarantees or else increase the prominence given to risk warnings, than the US Treasury Secretary, Hank Paulson steps in to underwrite such funds with Government money.

According to Reuters

The Treasury said it would back money market funds whose asset values fall below $1 a share. Separately, the Fed said it would lend money to banks to finance purchases of certain assets from money market funds.
Set to last for at least a year, it is understood that the guarantee is unlimited, transforming US money market funds into a far safer haven than bank deposits, which is sure to delight the banks [NOT!]. Significantly, might this have the unintended consequence of starting a switch of funds out of bank deposits to this new safe haven for anyone with funds exceeding the existing FDIC limits of $100,000 per depositor per bank, especially since money funds typically pay higher rates than bank deposits? Act in haste, repent in leisure?

The Treasury clearly acted to stem a panic and sudden exodus from such funds, current estimated at $3.5trillion, which would have created further havoc in markets. According to reports citing the Investment Company Institute, money-market fund investors withdrew a record $169 billion during the seven-day period that ended Wednesday. This was causing funds to hoard cash and buy Treasury Bills, which drove their yields down to virtually zero. In shunning the commercial paper they typically buy, yields on these assets shot up to 8% and according to the Wall Street Journal, even firms like IBM were paying 6% for money.

Interestingly it is suggested that a fee is going to be levied for this guarantee, without clarifying from whom this is to be collected - fund managers or investors? Likewise, it is unclear whether any investment constraints will accompany the insurance but this would seem reasonable to assume since otherwise reckless funds might invest in excessively risky assets to increase returns, knowing such "bets" were underwritten.

Prior to the announcement, the LA Times reported that
Legg Mason Inc. said it would make $630 million available to its funds to guard against losses, taking a hit against quarterly earnings. The Baltimore-based asset manager had already injected $2.2 billion into seven funds since November to cover potential losses on debt issued by so-called structured investment vehicles.

source Wall Street Journal

Labels: Money fund, money funds, Money market

posted by John Wilson @ 8:39 AM Permanent Link ,

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Money Funds - the mythical damn weakens Friday, September 19, 2008

I've written a number of times over the last year about money market funds [here, here, and here] and the myth surrounding "breaking the buck" i.e. the notion that they always return the capital invested and hence are safe. On a number of occasions during the last 12 months, Managers of money funds have been required to financially support them in order to preserve this fallacy i.e. directly top-up funds to maintain investors capital.

Money market funds invest in short-term money market instruments such as Govt Treasury Bills, Certificates of Deposit, and Repos. Such short-term horizons should minimise the likelihood of capital losses arising but cannot eliminate it and any losses directly impact the value of the fund.

As an industry, Money Market Fund Managers are very aware that if confidence in these funds were to be damaged and the illusion of safety to be impaired, the impact would manifest itself in huge withdrawals from a sector with trillions under management.

In 2008, the top ten Managers by funds under management were:

Fidelity $425.6bn
JP Morgan $267.9bn
Blackrock $259.8bn
Federated $231.1bn
Dreyfus $199bn
Schwab $194.4bn
Vanguard $191.4bn
Goldman Sachs $183.5bn
Columbia $146.8bn
Morgan Stanley $112.6bn

source FT.com

However, the fallacy was exposed this week when Reserve Primary's Money Market Fund was forced to announce that it had "broken the buck" - the fund was priced at 97cent following losses on Lehman short term debt. This is the first fund to actually price a fund at below $1 in 14 years, all other losses having been funded by the managers.

As I stated in past posts, most fund managers aren't capitalised sufficiently to provide such guarantees other than for small losses. It was for this reason that BNY Mellon and State Street both saw sharp falls in their share price, amidst concerns about potential money fund losses, with the former having admitted capital losses on one of its institutional money funds but confirming it would be supporting their net asset values.

At the same time, Putnam Investment decided to close it's money fund and return $12bn of funds to the investors. It did so not because of losses experienced, but because of the potential for losses especially after a period of heavy redemptions, when some assets may not have realised their value due to the need to sell them quickly to fund the said redemptions.

Given clear examples of implicit support by Managers, you would expect the regulator to either require these off-balance vehicles to be brought on balances or ensure risk warnings are given plenty of airing. Fund managers want neither of these, but unless something is done soon we may face a "mis-selling" scandal when a large fund encounters losses too great to be compensated by its' manager. Despite this, I doubt regulators will want to introduce any measures that could affect confidence in fund managers or the funds at present.

Labels: Money fund, money funds, Money market

posted by John Wilson @ 8:28 AM Permanent Link ,

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Barclays Global Investors takes a hit on liquidity funds Thursday, August 07, 2008

Included in Barclays Bank results today was the news, highlighted by the FT, that profits before tax at Barclays Global Investors, the investment management business, fell 32 per cent to £265m, after charges of £196m, which the bank said were related to “selective support of liquidity products” to help clients.

This is a similar tale to that of firms like Legg Mason, who've wished to avoid "breaking the buck" on their money funds i.e. reporting a capital loss to investors. The support has normally taken the form of buying certain assets, usually illiquid ones, from the funds at above market value and absorbing the loss.

I've commented on this before here, here and here.

Will someone break ranks and admit that these are risky investments or will these funds continue to be "protected" by asset managers, in which case at what point will they be forced by regulators to capitalise accordingly?

Labels: Barclays Global Investors, Barclays plc, Legg Mason, Money fund, money funds

posted by John Wilson @ 11:55 AM Permanent Link ,

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Liquidity pool for Auction Rate Securities is running dry Tuesday, March 11, 2008

For many years, Auction Rate Securities ("ARS") have been a competitor of money funds by virtue of their apparent liquidity and higher rates. ARS are municipal bonds, corporate bonds, and preferred stocks whose rates, or dividend yields, reset through "Dutch auctions, which typically happen every 7, 28, or 30 days.

Investors enter a blind competitive bid process via a broker to set the rate on the securities, with the lowest rate to clear the market applying for the next period. Investors can elect to
- hold existing positions regardless of the rate determined
- sell them regardless of the rate
- re-bid on existing holdings, which will be automatically sold if they bid too high
- buy holdings via the auction

However, you can only liquidate your existing holdings if there are buyers in the auctions. When they aren't, as is currently the case, then you are forced to hold the assets. Of course, if you don't need the cash, the good news is that when the market fails to clear and determine a rate, the issuer of the ARS is normally required to pay a punitive rate specified at issue [this may be an absolute rate of say 20% or a reference rate e.g. LIBOR + 800bp]. Naturally not good news for the issuer though who can find itself hit with a huge hike in interest costs. To illustrate The Port Authority of New York and New Jersey, ended up paying 20% rather than 4% on their loan – costing them an extra $300,000 a week.

Depending upon their view of conditions and the terms of issue, issuer could redeem the bonds and re-finance them, but it's not obvious where such financing will come from in some cases. Bloomberg reports that New York plans to sell $448 million to refinance debt, including auction-rate securities. The Port Authority of New York and New Jersey is refinancing $700 million of auction-rate debt after interest costs jumped as high as 20 percent. The California Statewide Communities Development Authority may offer as much as $10 billion of notes.

Banks with stretched balance sheets are unwilling to act as buyer of last resort in these auctions, nor are they legally obligated to make a market in ARS.

From recollection, US money market funds cannot own the bonds. Thus, the biggest investors in auction-rate securities are individuals and corporations, some of whom are now insisting they were mis-sold the investment as "cash equivalents" by brokers - queue more litigation.

One group hard hit are VC-backed companies, which invested the cash they got from VCs in these securities, pending use. For me, this demonstrates dumbness on the part of the VCs affected as they evidently took little interest in how cash was being used - "the good news is the cash burn rate is low, but did we mention the mattress we used is burning?". Is it wise to leave cash investment to inexperienced firms? The result is that these early stage companies now find themselves strapped for cash.

SEC's Division of Corporation Finance has had to remind US corporations who made considerable use of these instruments to properly classify them. "Auction rate securities are not cash or cash equivalents -- they are investments," emphasising that impairments of the securities should make auditors give them a second look.

Labels: auction rate securities, credit crunch, money funds

posted by John Wilson @ 4:40 PM Permanent Link ,

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Money Funds - Are the harbour walls safe?

With the turbulence in the markets and credit markets in particular, money funds have found themselves awash with cash from investors seeking a home for their cash during the storm.

Money funds are mutual funds that normally carry a triple AAA rating, whose portfolios are made up of short-term financial assets with high liquidity (Treasury Bills, Commercial Paper etc). InvestorWords quotes

The main goal is the preservation of principal, accompanied by modest dividends. The fund's Net Asset Value remains a constant value ($1/£1 etc) per share to simplify accounting, but the interest rate does fluctuate. Money market funds are very liquid investments, and therefore are often used by financial institutions to store money that is not currently invested. Although money market mutual funds are among the safest types of mutual funds, it still is possible for money market funds to fail, but it is unlikely. In fact, the biggest risk involved in investing in money market funds is the risk that inflation will outpace the funds' returns, thereby eroding the purchasing power of the investor's money.

The emphasis is mine, since this point has been under stress for some time.

Sold to both retail and corporate investors across a range of currencies, the marketing of such funds has traditionally focussed upon five things namely:

their rating, usually AAA
their liquidity, normally with daily access
ease of use
low risk, diversified holdings versus concentration of risk by holding a bank deposit
wholesale market rates offered, which are normally higher than rates offered to bank customers

These funds have been incredibly successful in attracting deposits, especially in the US where such funds exceeded bank deposits some years ago. The industry association, The Institutional Money Market Funds Association (IMMFA), publishes a weekly summary of its' members offerings and at 1 Feb 2008 reported balances of $300bn in US dollar denominated funds (47 funds), Eur70bn in Euro funds (40 funds) and £80bn in stering funds (36 funds).

Obviously investor confidence is of paramount importance especially when competing against bank deposits and loss of capital value would come as a major shock to many investors. Mindful of this, a number of funds have been bailed out by their managers to maintain the capital protection illusion. Back in December, the FT reported that more than 10 North American banks and fund managers have collectively injected $3bn into their money market and cash funds since October to stem losses. It added that not all bail-outs have been made public but more were believed to be being drawn up and that the extent of losses is not yet known.

It takes only a tiny loss to push a fund's value below 99.5% and given that such funds have to mark their asset to market, the continued downward pressure on assets prices of even US Federal backed paper will challenge the pretence. When this happens, some investors may panic causing a "run" on such funds.

In common with banks, such funds also tend to borrow short-term and buy long-term paper whilst maintaining sufficient liquidity to meet investor redemptions. However, in the event of higher than foreseen redemptions, the lack of liquidity in the markets could result in funds either having realise cash by selling assets cheap, thereby incurring losses or suspend redemptions. This latter outcome is like a bank shutting its' doors but it has happened with several money fund managers.

You may think banks would be delighted to see their "competitors" struggle. Not so, since many of them are the managers of such funds having seen the benefits of a large chunk of existing business moving off-balance [removing any capital requirement] whilst generating broadly the same returns.

So the challenge is this - as fund balances swell from inflows, managers have to find more investment outlets. In doing so, they have to be more cautious than most given the imperative of preserving capital and having access to liquidity. Yet finding large assets pools matching this profile in the current climate will be immensely challenging. As a consequence, rates offered may have to be tempered, and whilst high inflow levels might allow for that, managers will still feel the need to competitively price their offering.

Mistakes will be inevitably made in these stormy waters. So will the sea defences hold or might urgent and rapid bailing out of these "safe harbours" be necessary or will the scenes around the South of England yesterday be repeated and the harbour walls be breached? Right now, there are many senior executives probably praying for survival.

UPDATE: Financial News has the following report

Legg Mason has provided support to one of its cash funds with a holding in Cheyne Finance to prevent its investment in the structured investment vehicle from dragging the fund down.

Officials at Legg Mason declined to reveal the size of the fund's holding in Cheyne Finance. In December, Deloitte & Touche—acting as receivers for the vehicle—revealed it had agreed to sell the $7bn portfolio to a new vehicle managed by investment bank Goldman Sachs.

Legg Mason has provided $1.57bn of support to a variety of its money funds, according to analysts at investment bank Keefe, Bruyette & Woods, including posting $440m of cash collateral and the direct purchase of $181m of securities.

In November last year, the firm signed letters of credit worth $238m to keep the high credit ratings on two of its money market funds that had a total exposure of $670m to asset-backed commercial paper issued by structured investment vehicles. In October, it invested $100m in another liquidity fund managed by a subsidiary "in order to provide additional liquidity support to the fund."

Exposure to structured investment vehicles has affected a range of money market funds, forcing some asset managers to spend millions of dollars support them in order to avoid the stigma of "breaking the buck"—where an investor receives less than a dollar for each dollar they originally invested in the fund.

Asset managers Northern Trust, Bank of America, Wachovia, Credit Suisse Asset Management, Janus Capital and Morgan Stanley Investment Management have all faced charges or arranged lines of credit related to keeping their money market funds' value at par.

Labels: Hedge Funds, money funds

posted by John Wilson @ 8:30 AM Permanent Link ,

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Zopa goes State Side with Federal backing (allegedly) Friday, November 30, 2007

According to report at Techcrunch, Zopa, the peer-to-peer lending platform is to launch in the USA. However, the major element of the annoucement that caught my eye was that Zopa claims that the loans would be Federally insured and hence, if true, the credit risk element would be effectively be stripped out but the rates could continue to attract personal lending rates (less the Fed insurance premium that I'd anticipate would be deducted from the rate by the platform).

This would be likely to attract serious funds, since the deemed rating on these would be AAA as USA Govt backed loans. As such this could become a popular asset class, especially if the value of each lenders insured amount on the platform weren't be capped. Why is that notable? Well for a start, if you ordinarily deposit with a bank, you are only covered up to $100k. But if you instead deposited with Zopa, all your deposits would be covered by Fed guarantee whilst still attracting decent interest. Secondly, high net worth or institutional investors might place deposits on the platform as part of their bond allocation. Whilst these loans couldnt be traded or collateralised, they would be secured and attract a reasonable return on the asset and at a premium to T-Bills even though the risk is the same.

The same Techcrunch article highlights that
According to the research firm Online Banking Report, around $100 million in new P2P loans will be issued this year, mostly by Prosper, with new loans growing to as much as $1 billion in 2010 and $9 billion in 2017. Prosper already registered an S-1 with the SEC and reported $96.4 million in loans.

I think the supply of funds could go way beyond that and directly compete for business with money funds. In the USA, assets in US money market mutual funds hit $3,031bn this week according to iMoney.net, with $13.38bn of new monies in the week ended 27 Nov.

Labels: money funds

posted by John Wilson @ 8:35 PM Permanent Link ,

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