Comments on: Where should mutual funds invest their repo collateral?

By: David Merkel

David Merkel — Mon, 01 Jun 2009 14:55:17 +0000

Felix, it’s a question of getting the risks that you want to take. Why should I find out that I lost money on subprime ABS, when I thought I was buying a stock fund? Unless it is prominently disclosed that they are taking abnormal fixed income risks — warning kids, don’t try this at home — they should stick with safe, vanilla collateral.

By: Max

Max — Mon, 01 Jun 2009 01:29:23 +0000

Felix, you’re dead wrong on this. If a fund can’t make money on lending when the collateral is invested in t-bills, it shouldn’t be lending. Have we learned nothing about the dangers of hidden risk?

By: David Schenker

David Schenker — Mon, 01 Jun 2009 01:29:16 +0000

Mutual funds’ record with respect to repos and sec ending is far superior to that of pension funds, corporations and other market participants due to Investment Company Act rules that set standards for the amount, quality, and segregation of collateral.

By: drscroogemcduck

drscroogemcduck — Sun, 31 May 2009 20:34:49 +0000

isn’t this how aig blew up. they were loaning out securities and taking treasuries as collateral then swapping the treasuries for MBS.

By: nadezhda

nadezhda — Sun, 31 May 2009 19:30:24 +0000

When I select a mutual fund, it’s on the basis of my investment objectives (e.g. capital preservation vs return, etc) and with at least a vague view (what’s likely to happen to exchange rates, interest rates, which countries or industries likely to do well/poorly, etc.). I want a fund manager who’s going to invest in a portfolio that fits with my objectives and view. And that goes as well for how collateral is invested.

What I don’t want is a manager who, as Mark describes, is “trying to goose an additional few bps by speculating in riskier securities for 30-days (or less) at a time.” That’s not the portfolio I was buying, thank you very much.

Unfortunately for a small investor, the fine print in fund prospectuses often give the fund manager a whole lot of lattitude. So we’re stuck with having to trust the good sense of fund managers. Even though there are immense incentives for them to “goose their return”.

By: cgaros

cgaros — Sun, 31 May 2009 19:04:32 +0000

Mark: So it’s okay for a mutual fund to invest in GE common stock but it’s not okay for a mutual fund to invest in GE commercial paper or asset securitization? Huh?

This post also relates to the more recent post about Gary Gorton’s foolish idea to create government-backed securitizations so that the shadow banking system can function with no credit risk. T-Bills already provide everything that such a system would provide (plus a ready source of cheap funding to the government). Why should the government crowd out demand for T-Bills by subidizing the private-sector creation of high-denomination informationally insensitive assets? It would be yet another private profits/public risk situation – banks and depositors would profit from the spreads between T-Bills and these securities, while the government would take on the cost of regulation and the risks of bailing out securities or being subject to fraud.

By: Mark

Mark — Sun, 31 May 2009 17:10:15 +0000

Huh?

The vast majority of repo activity is in term repos and reverses. Mutual funds are already earning the repo rate on the transaction. Mutual funds shouldn’t be in the business of trying to goose an additional few bps by speculating in riskier securities for 30-days (or less) at a time. That’s not facilitating the efficient allocation of capital. It’s a time-honored recipe for wild and irrational swings in market prices — exactly what you’d expect when you incentivize mutual funds to become momentum traders.