Normally, these newsletters go out twice a month, but with all of the turmoil in the markets, I thought a special report was in order.
If Not Now, When?
No one pays attention to money market funds until they really need them. After all, a 4% dividend is just not sexy. Until you put it next to a big minus something, then it looks darned good!
Both the stock market and parts of the bond market have been dishing out a lot of red ink lately, making money market funds an important investment tool right now. Hopefully you have a money manager who is using them.
Earlier today, I had a conversation with a man who invests with another firm that bills themselves as money managers. He was upset because they had 80% of his money still invested in the stock market almost 4 weeks into this decline and he had lost a lot of money. I think he expected more management than he has been getting and wanted to know what we had been doing in this market. I was able to tell him that we had begun hedging operations on July 24th, three trading days after the market peak and right then (August 15th) our stock portfolios were averaging 70% in the money market fund*, with the remaining investments well hedged to reduce risk.
* Incidentally, a complete list of holdings and all trades done in our strategies for the past 12 months is available by calling the office at any time. 778-4000.
My point about money market funds is that they only work if a manager uses them. Keep in mind that every 20%, 30% or 40% loss in the markets begins with a small decline. At this writing, the S&P 500 index is down 9.4% from its peak and has lost money for the year. A 9% loss may not seem small until you compare it to 2000-02’s loss of 48%.
I certainly don’t know if the current decline will end up creating a hole as big as 2002, but today’s economic problems sure seem like the type that could become a big deal. (Don’t they always?) On the other hand, the government says they will pump money into the system to prop it up and it is usually a good idea to not try to fight the Fed. All I know is the list of casualties in this market crunch is growing daily, and no one knows what will happen next. If an unexpected negative event were to shake the markets now it is possible that a cascade of selling could occur. If that happens it would be hard to say we weren’t warned. Right now, I am more concerned with protecting principal than possibly missing a move up in the markets.
That is why I have chosen to stand aside and let the market sort itself out. When things stabilize, which shouldn’t take too long, the market leadership will probably be different, so cash will be needed to buy different investments for the portfolios I manage. Being prepared to buy low at the other end of all this is another reason I decided to raise cash. That, after all, is the goal. Buy Low, Sell High, Repeat.
The question I suggested my caller ask his money manager in regards to defending his principal was “If not now, when?” In effect, how many read flags does one need?
There is a time to be invested and there is a time to be in a money market fund. Unfortunately, most investment firms are just not set up to move your money out of the market in a timely manner. I am. If you or someone you know has money I do not yet manage, perhaps you should ask yourself “When do you shift from offense to defense?” If you don’t have an answer, we should talk.
Junk as Broke Buck Mountain?
Since we are talking about money market funds in this report, do you know what a money market fund actually is?
They are really just bond mutual funds where the entire portfolio averages less than 100 days to maturity. Normally pretty stable stuff. But all money market funds are not alike.
Investors who shop for the highest possible rate they can find on a money market may unwittingly be buying a junk bond fund. Junk bonds are issued by companies that have weak credit and carry a higher risk of default. Credit defaults are at the heart of our market problems today, so this tendency for investors to seek out the top rates has the potential to become a big problem.
The markets had a real scare yesterday when the financial news station reported that a money market fund had notified the regulators that they were defaulting. If that were to happen investors in the money market fund would get back less than $1.00 per share. It is called “breaking the buck” in industry terms. Fortunately for everyone, CNBC was wrong and it was a hedge fund, not a money market fund that was in trouble. So the money market industry’s reputation of never having broken the buck is still in tact – for now.
So, do you know what your money market fund invests in? Now is the time to ask, not after there is trouble. Ask your money market fund sponsor for a prospectus and see what your fund invests in. What should you look for? The money market fund we use in our brokerage accounts hold only US Government and AAA bonds. I would accept nothing less than that.
When I am in a money market fund it is because nothing out there looks very good and risk is very high. The last thing you want at a time like that is to be taking risk with what you believe is your “safe money”.
Signed: Will Hepburn