The demise of Community Asset Management's taxable money market fund has tax-exempt money market fund portfolio managers and mutual fund company executives on the defensives explaining and educating investors about their derivatives investments.
"I do think it's reasonable to assume that investors will notice this and make calls," said Stephen N. Van Order, head of fixed-income trading at Calvert Asset Management Co.
Calvert and several other mutual fund companies reported receiving calls from anxious investors last week inquiring whether their tax-exempt money market funds contain derivatives.
Meanwhile, municipal fund company executives are characterizing the down-fall of Community Bankers U.S. Government Money Market Fund as an isolated incident. In addition, they're pointing out that they adhere to Rule 2a-7 and other suggestions by the Securities and Exchange Commission to avoid certain types of derivatives investments deemed inappropriate for money market funds.
Municipal fund managers also said that the derivatives they use generally comprise variable-rate demand notes or tender option bonds, some of the most generic and conservative of investments that can fall under the derivatives umbrella.
The plight of Community Bankers U.S. Government Money Market Fund came to light last Tuesday during congressional testimony by SEC chairman Arthur Levitt Jr.
Testifying before the House Energy and Commerce Committee's subcommittee on telecommunications and finance, Levitt said the collapse of the Community Asset Management Inc. fund highlighted the need for regulations governing funds' illiquid holdings and disclosures of derivative securities.
The Community Bankers fund began redeeming shares for less than $1 last Monday after the value of its derivatives holdings plummeted. It is the first such fund, at least in recent history, to "break the buck."
In anticipation of possible investor inquiries, several companies, including Calvert, have issued statements on their derivatives investment policies.
"The taxable market is really where we saw a lot of this paper," Van Order said, referring to the leveraged derivatives that plagued the Denver-based fund.
"I saw a few trial ballons where people said ~are you interested in the structure?'" Van Order said. But the municipal market "was late in the game," and before a lot of the securities could be issued, interest rates began rising, the fund executive said.
"There's probably very little if any in the tax-exempt money fund world," Van Order said.
"Every time there's an article, there's a pretty good followthrough from shareholders and internal people," said Walt Beveridge, a portfolio manager for Charles Schwab Corp.
Beveridge said Schwab's two tax-exempt money market funds, each with more than $1 billion of assets, can invest in derivatives such as tender option bonds. But each fund holds less than 5% of such securities.
Schwab maintains a conservative stance on derivatives, Beveridge said.
"We already have limits in place and they're very conservative. We don't think we would have a problem," he said.
T. Rowe Price received about two dozen calls from investors inquiring about whether its money market funds contain any derivatives, said spokeswoman Rowena Ichon.
The firm's $742 million national tax-exempt money market fund can invest up to 5% of its assets in put bonds. Currently, the fund holds no derivatives, Ichon said.
Earlier this month, Evergreen Funds, a Purchase, N.Y.-based mutual fund company, sent investors a flyer explaining the company's guidelines on monitoring derivatives investments.
Fidelity Investments included questions on derivatives in its recent semi-annual report. The company also has an education brochure on derivatives available to investors who request it.
With all the negative news about derivatives, mutual fund executives are skittish even of reporter inquiries about derivatives use.
"Our funds have never had to bail out a security," one mutual fund spokeswoman said. In light of that, it is "unfair" to mention the fund company prominently in an article about troubled derivatives investments, the spokeswoman said.
Another money market fund manager declined to comment on the record, citing concerns that publicity and some misinformation about mutual funds and derivatives have caused heightened concern among investors.
"There are no tax-exempt funds on that list" of mutual funds that have had problems with derivatives, said the fund manager, who asked that his name not be used.
"That has been the most frustrating thing for me as a tax-exempt portfolio manager. There's just this kind of guilt by association.
"The types of products that seem to have been going sour in the taxable sector are not similar to the types of securities that we buy. From generalizations that I can make, we're talking apples and oranges," the fund manager said.
"We don't have any bad derivatives," a Fidelity Investments spokeswoman said, when asked to comment on the issue.
The problems with some speculative derivatives investments have even raised concerns for municipal issuers, one executive said.
"Virtually all of the losses reported in the press have concerned highly speculative derivative investments," said J. Donald Rice Jr., president and chief executive officer of GB Derivative Products Co. in New York City.
"It is important to distinguish these investments from the basic non-investment, interest rate swap based on debt management tools that have been successfully used by municipalities for many years," Rice said. "While they each fall under the term ~derivative,' they have little else in common. A floating-to-fixed interest rate swap for example, is not an investment; it involves no principal and reduces an issuer's exposure to variable interest rates," Rice said.
