Covered and Exposed, but by how much?

Did money market fund investors fully appreciate how the Treasury's Temporary Guarantee Program ("TGP") impacted the benefits and cost of coverage?

Firstly, the overall cost was not substantial as a percentage of assets in the money market funds. For the initial period of the program and its subsequent two extensions, participating funds paid 0.01%, 0.015%, and 0.015% of the "Covered Assets" (i.e. value of shares outstanding as of September 18, 2008) for each period. Hence, the total cost of participating for the full term was 0.04% of Covered Assets. Remember that Covered Assets never adjusted for any investments and redemptions which occurred after September 18, 2008 ("Cut-Off Date").

(We need to define one more term before pressing ahead: Shares purchased in excess of the account balance as of the Cut-Off Date would not be covered under the TGP; we shall refer to them as "Exposed Assets".)

Given that every share of a mutual fund (technically, within one class of shares) must be charged the same fees, every share must pay its share (no pun intended) of the cost of participating in TGP (for lack of a better term, "TGP Premiums"). Therefore, Exposed Assets paid part of the TGP Premiums even though the Treasury excluded coverage for losses on Exposed Assets if the fund NAV price dropped below $1.00 (or $0.995 to be accurate).

Was the amount of TGP Premiums paid a material sum to make it worthwhile to even further this discussion? That depends on whether you consider $1.2 billion to be "material". The Treasury indicated that they would keep the TGP Premiums in its Exchange Stabilization Fund. (By the way, $1.2 billion is approximately 0.04% of $3 trillion.)

A small study, including a simple simulation, can shed some light on how much investors might have paid for insurance with respect to Covered Assets and Exposed Assets.

All registered mutual funds publish their monthly sales and redemptions via the SEC's web site. Each fund must report individually for each month, albeit with a few months lag. By looking at sales and redemptions for every month and every fund, one can try to estimate how much Covered Assets stayed in the funds, with the remainder comprising Exposed Assets. At this point, these estimates cannot be validated with account-level data, which is not trivial to gather and otherwise non-public.

Given that the TGP ended on September 17, 2009, we don't have enough data to carry the analysis through the end of the program. However, as of October 2009, a sizable minority of funds have reported sales and redemptions through June 2009. Total assets range from approximately $550 billion to $700 billion. With time, as funds disclose their historical figures, more assets can be included in this analysis.

For now, the selected sample reflects data for 10 of the largest fund families, excluding money market funds which invested primarily in Treasurys. Midway through the TGP, a number of fund families chose for certain Treasury and Government funds to stop paying for the TGP given that their primary investments were in securities issued by the government. This exclusion simplifies the analysis and keeps samples consistent with each other.

Let's jump into the results. For now, we can assume that investors in Covered Assets end Exposed Assets purchased and redeemed shares in the same proportion as their corresponding balances. For example, given a balance of $400 for Covered Assets and $200 for Exposed Assets (i.e. split 67%/33%), one-month activity of $120 in purchases and $150 in redemptions would be allocated accordingly ($80/$40 for purchases and $100/$50 for redemptions).

(Note: Since the analysis covers the period ending June 30, the entire TGP Premiums are less than would be expected given the 0.04% rate. In other words, through June 30, the Treasury probably collected $1.2 billion of TGP Premiums, but not all of the premiums were fully earned. The resulting adjustment assumes that, as of June 30, the TGP had another 2.5 months until expiration on September 17.)

In the table above, the split between Covered Assets and Exposed Assets is shown in the orange cells. The respective split in TGP Premiums is shown in the green cells. In this case, investors owning Exposed Assets paid only $19 million of premiums. On an average asset base of $159.3 billion, that comes to a rate of only 0.0117% (1.17 bps). Another way to measure their contribution: Exposed Assets covered 10.6% of the total TGP Premium. Not so bad considering that Exposed Assets represented 24% of average total balances. (Remember, all of these results are estimates based on a cash flow model.)

Here is a graph showing the trend in Covered Assets and Exposed Assets during the simulated period.

So what happens if, after September 18, 2008, purchases into these money market funds came more so from investors who had very few, if any, shares in money market funds before the Cut-Off Date? Let's assume that, all else equal, purchases only are split 50/50, where as above the split was 67/33. This might be a more realistic scenario because few investors expected Lehman to go bankrupt, starting a cascade of events which resulted in the TGP, and resulting in a rapid growth rate of Exposed Assets.

Now Exposed Assets comprise, on average, 32% of the total assets. Investors owning Exposed Assets paid only $48 million of premium. On an average asset base of $211.5 billion, that is a rate of only 0.0228% (2.28 bps). Another way to measure their contribution: Exposed Assets covered 27% of the total TGP Premium. Exposed Assets and Covered Assets are charged more comparable rates (2.28 bps versus 2.91 bps, respectively) for insurance, even though only investors in Covered Assets can receive a payout if a money market fund's NAV price falls below $1.00.

Here is the graph corresponding to this second scenario.

Finally, we can take this analysis one notch further (for academic purposes). Let's assume that, all else equal, purchases only are split 33/67 (inverse of the split used in the first scenario).

The trend should be self-evident. Exposed Assets comprise, on average, 47% of the total assets. Investors owning Exposed Assets paid only $77 million of premium, resulting in a rate of 0.0250% (2.5 bps). Although the rate is only marginally higher than in the previous scenario, Exposed Assets covered almost 44% of the total TGP Premium. Interesting, for an academic example.

Here is the graph corresponding to this third scenario.

The critical question: how much did investors add to their existing money market fund balances after September 18, 2008? The money market funds, with help from their transfer agents, have access to data to answer this question. The accurate way to quantify Covered Assets and Exposed Assets would be to look at account level activity, while not complicated would be extensive given the number of accounts held in retail money market funds. Although an industry-wide analysis may be burdensome, specific fund sponsors can perform the analysis individually.

In the meantime, the above scenarios simulated by a cash flow model can only demonstrate the general impact. Check back later for future updates of the numbers and further commentary.