The Wall Street Journal-20080213-Funds Feel Dearth of Tax-Free Securities
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Funds Feel Dearth of Tax-Free Securities
Full Text (648 words)The turmoil in the municipal-bond market sparked by the bond insurers' woes has caused at least three municipal money market funds to buy taxable securities, which could result in unexpected tax bills for investors in the funds.
TD Asset Management USA Funds Inc., a subsidiary of Toronto-Dominion Bank, resorted to buying Treasurys, agency debt and other taxable securities for three municipal money-market-fund portfolios late last year. Normally, such funds buy only tax-free municipal securities. By contrast, investors must pay tax on the interest payments generated by most bonds, including Treasurys.
It's not clear if other fund companies besides TD Asset Management made such a move. Firms usually have the leeway to own some taxable debt in their tax-exempt funds without having to notify shareholders, and other fund managers acknowledge the challenge of finding safe municipal securities in today's tumultuous market.
"The real issue in the tax-exempt market today is the lack of suitable supply," says Steven Meier, chief investment officer of global cash at State Street Global Advisors, which hasn't bought taxable securities for its municipal funds.
The problem is that money funds are getting squeezed from several angles. Investors have been pouring cash into tax-exempt money-market funds in recent years. They now hold $466 billion, up from $368 billion a year ago.
But the market for many kinds of short-term debt that are popular holdings in money-market funds have been roiled by the financial troubles of bond insurers such as Ambac Financial Group Inc. and MBIA Inc. that provide guarantees to investors that the issuers will make their payments. Woes facing these companies, caused by their backing of troubled debt backed by risky mortgages, have led to ratings downgrades on several, including Financial Guaranty Insurance Co. and Security Capital Assurance Ltd. Such downgrades can then translate into lower ratings for the debt they guarantee.
These downgrades -- and the potential for more to come -- present a big problem for money-market funds because they could lead to price declines on bonds backed by downgraded insurers. Meanwhile, a hallmark of money-market funds is the promise of keeping the share price stable at $1. If enough securities fall in price the choice for the fund manager is allowing the fund to "break the buck" and having investors lose money or stepping in and covering the investment losses. That's what a number of fund companies had to do late last year for their taxable money-market funds, a step that required them to cover hundreds of millions of dollars in such holdings to plug the gap.
Faced with this prospect, many tax-exempt money-market funds have been bailing out of debt associated with troubled bond insurers. The question then, is what to buy in its place. For example, the number of securities either already affected by ratings downgrade or facing the risk of downgrade by Fitch Ratings tops 470,000. Last year, bond insurers backed roughly 50% of all new debt.
Late last week TD Asset Management notified shareholders that it had put portions of the TDAM Municipal Portfolio, California Municipal Money Market Portfolio and New York Municipal Money Market Portfolio in taxable money-market investment after removing debt backed by bond insurers.
"There was a shortage of quality municipal paper we wanted to invest in" at the time, says managing director David Hartman. He says the funds have since returned to an almost fully tax-exempt position in the funds and aim to continue in that vein to keep any tax impact "de minimus" this year, he says. The TD Asset Management funds, like other municipal funds, need to have at least 80% of total assets invested in municipal securities, but wiggle room exists in the remaining portion.
That language is there "for extreme circumstances," says Pam Tynan, a portfolio manager at Vanguard Group. Vanguard Group hasn't taken that step, she says. Adding taxable securities to a tax-exempt fund is "a pretty serious decision."
