Wake Up That Sleepy Money

Put your idle cash to work and eliminate unnecessary fees from your portfolio.
by , | October 13, 2011

Today's low interest-rate market environment leaves municipal treasurers and cash managers scrounging around to scrape up every nickel of investment income they can find. In this environment, investment-related fees and expenses are magnified because they consume so much of the puny earnings on idle cash. One often-overlooked place to cut costs is the bank trustee or fiscal agent where your bond proceeds are invested.

Many municipal bond issuers use a bank trustee to hold the proceeds of the issue until spent, as well as debt service reserves that are sometimes required by the indenture. This arrangement assures the investing muni bond purchasers that the money will be prudently invested as required by the indenture.(So far, so good.) But what many municipal officials often overlook is the practice of some banks to "sweep" idle cash into a higher-fee money market mutual fund that pays them a "12b-1" fee or a similar administrative reimbursement. Such funds typically have much higher retail expense ratios than the low-fee institutional money market mutual funds and local government investment pools that public cash managers typically use for their general fund portfolios.

When overnight interest rates were much higher and bond issuers had no financial incentive to control fees because the incremental earnings were rebatable to the U.S. Treasury under its arbitrage regulations, these arrangements had no impact on local taxpayers, but those days are long gone. In some cases, the result today can be a zero interest rate on the retail fund, which means that all the investment income from that product is siphoned off to pay the money manager and the bank. Needless to say, there are not many taxpayer advocates or news reporters that would take too kindly to that arrangement. Talk about headline risk!

Many bond indentures authorize the issuers' finance officials to direct the trustee to sweep their idle cash in a bond-proceeds account into a specific legally permitted lower-fee, higher-yielding instrument such as those mentioned above. When there are millions of dollars in play, it doesn't take a genius to figure out that a five, ten or fifteen basis point yield difference is worth the effort. (One basis point = 1/100th of one percent.) In many cases, this amounts to thousands of dollars annually.

So check your bond indentures, talk to your bankers, and eliminate 12b-1 (marketing and distribution) fees from your portfolio. Those are retail-oriented features that have no place in a public portfolio.

Disclaimer: Girard Miller's comments, suggestions and views herein are his own general opinions and do not constitute specific investment advice nor an offer to buy or sell securities. His independent views do not necessarily reflect those of any organization with which he was or is presently affiliated, including his employer PFM Asset Management LLC, and any registered investment company or statewide investment pool it advises.

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