Vanguard subsidizing money market funds by $100 million

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asset_chaos
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Vanguard subsidizing money market funds by $100 million

Post by asset_chaos »

Vanguard's money market funds annual report (dated end of Aug 2021) hit my inbox today. Normally I don't read money market fund reports, but did this one because I'm curious to understand the difference between Cash Reserves Federal Money Market Fund (what used to be prime money market) and Federal Money Market Fund. However, what struck me is the size of Vanguard's expense reduction for all their money market funds, presumably in order to prevent the funds from having negative yields. Quoting note B from the reports, I've bolded the dollar amount of the expense reduction for each fund:

o for Cash Reserves Federal Money Market Fund (formerly prime money market)
For the year ended August 31, 2021, Vanguard's expenses were reduced by $50,709,000 (an
annual effective rate of 0.06% of Investor Shares' and 0.03% of Admiral Shares' average net
assets); the fund is not obligated to repay this amount to Vanguard.
o for Federal Money Market Fund
For the year ended August 31, 2021, Vanguard's expenses were reduced by $49,701,000 (an
effective annual rate of 0.02% of the fund’s average net assets); the fund is not obligated to repay
this amount to Vanguard.
o for Treasury Money Market Fund
For the year ended August 31, 2021, Vanguard's expenses were reduced by $5,204,000 (an
effective annual rate of 0.01% of the fund’s average net assets); the fund is not obligated to repay
this amount to Vanguard.
The amount in basis points relative to the funds' sizes is tiny, but the absolute dollar value is over $100 million. That seems like a lot of money that has to come from somewhere else in the Vanguard organization. And the expense subsidy also puts paid to the idea that Vanguard charges at cost for each fund. I'm not suggesting there's anything nefarious about this; just that the size of the expense subsidy seems remarkably large. And it's also an example of how keeping interest rates so low for so long makes weird things happen.
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markjk
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Re: Vanguard subsidizing money market funds by $100 million

Post by markjk »

Keep in mind vanguard has trillions of $$ under management. Not one trillion, but something like 7 trillion worldwide. When you manage that much money, 100,000,000 is not even close to a statistically significant number. I'm sure they care, but I just want to put the numbers in perspective.

There are management functions that go into all of the funds so the costs are defendable. In the case of money markets, you nailed it when you said "... keeping interest rates so low for so long makes weird things happen." In this case the weird thing is losing money on a money market. It's nice that Vanguard is making the adjustment rather than passing the losses on to it's customers.
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Re: Vanguard subsidizing money market funds by $100 million

Post by jeffyscott »

asset_chaos wrote: Wed Oct 27, 2021 4:05 am And the expense subsidy also puts paid to the idea that Vanguard charges at cost for each fund.
Especially since they say the funds are not obligated to repay these subsidies. In contrast, when other mutual fund companies are subsidizing the ER, such as for a new fund, there is sometimes (usually :?: ) language about reimbursement of the subsidy under certain circumstances, so those may effectively become a subsidy from future shareholders of the fund being paid to the current shareholders.

I wonder if they had also explicitly stated the subsidies in this way back when they launched their ETFs with the same ERs as Admiral shares? (I assume the actual cost of running those was not equal to the cost of the existing mutual fund shares at their launch.)
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Re: Vanguard subsidizing money market funds by $100 million

Post by JoMoney »

Keep in mind that "Expense Ratios" are calculated a specific way, and do not include all costs, nor additional ways the funds may earn income.
I don't know all the inner workings of the fund(s), nor have I gone over the annual report accounting and balance sheets, but it's entirely possible these money markets are still profitable or economically self-sufficient even if the yield on the investments is less than the statutory ER (which is not all-encompassing)
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Re: Vanguard subsidizing money market funds by $100 million

Post by arcticpineapplecorp. »

why do the funds have to come from somewhere else? if they reduced the fees, could it not be less expensive to operate the funds and they're passing those savings onto the investors in these funds?

S&P500 index fund used to cost .20% when i started investing and now costs .04%. There has been no subsidy with that fund to my knowledge, Vanguard lowered the cost to operate the fund.

is it different with money market funds?

i do find the phrase not obligated to repay Vanguard interesting but couldn't it just mean the funds are passing the savings along to investors in the fund, rather than to Vanguard who found cost savings?
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Re: Vanguard subsidizing money market funds by $100 million

Post by prd1982 »

arcticpineapplecorp. wrote: Wed Oct 27, 2021 8:45 am
i do find the phrase not obligated to repay Vanguard interesting but couldn't it just mean the funds are passing the savings along to investors in the fund, rather than to Vanguard who found cost savings?
I believe Vanguard is waiving their fee because interest rates are so low. Once interest rates go up, expect the fee to resume. I assume the “not obligated to repay” to mean VG will not be asking to retroactively collect the money once interest rates go up.

I think VG had to reduce their fee to keep their MM funds at $1.
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Re: Vanguard subsidizing money market funds by $100 million

Post by goodenyou »

Necessity is the mother of invention. It appears that Vanguard is “finding” efficiencies when necessary and subsequently lowering expense ratios. There should be lower cost friction in financial transactions with technology and those costs savings should be passed along. There appears to be some latitude in the cost structure of money market funds to maintain a near zero (and not negative “buck breaking “) return.
Last edited by goodenyou on Wed Oct 27, 2021 8:59 am, edited 2 times in total.
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Re: Vanguard subsidizing money market funds by $100 million

Post by alex_686 »

arcticpineapplecorp. wrote: Wed Oct 27, 2021 8:45 am why do the funds have to come from somewhere else? if they reduced the fees, could it not be less expensive to operate the funds and they're passing those savings onto the investors in these funds?
Because if expenses were reduced then the expense ratio would be reduced.

Fee waivers specifically mean that the fund sponsor is covering some of the fund's cost.

The regulations around this are very specific. Funds are supposed to be self-sufficient. Cross subsidization of funds - which transfers assets from one set of shareholders to another - is discouraged.
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Re: Vanguard subsidizing money market funds by $100 million

Post by retiringwhen »

prd1982 wrote: Wed Oct 27, 2021 8:51 am I believe Vanguard is waiving their fee because interest rates are so low. Once interest rates go up, expect the fee to resume. I assume the “not obligated to repay” to mean VG will not be asking to retroactively collect the money once interest rates go up.

I think VG had to reduce their fee to keep their MM funds at $1.
And, every single other money market mutual fund is doing the same thing to keep their price at a $1. Money markets really are odd ducks in the mutual fund landscape and the need to perform such a subsidy is just one more sign of their oddness.

I am guessing that Vanguard's at-cost and non-subsidy policies and agreement with the SEC have specific exemptions for money market funds for that very reason.

The lowering of the S&P500 fund expense ratios were a long-term realization of actual cost reductions through scaling and improved operations not subsidies. Same with ETFs. I am guessing that we will continue to see the ETF costs get lower and lower over time relative to the mutual fund classes, especially as the ETF share class AUM increases as a percentage of the overall funds. The bookkeeping and trading costs are almost nil for the ETFs.
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Re: Vanguard subsidizing money market funds by $100 million

Post by stan1 »

alex_686 wrote: Wed Oct 27, 2021 8:59 am The regulations around this are very specific. Funds are supposed to be self-sufficient. Cross subsidization of funds - which transfers assets from one set of shareholders to another - is discouraged.
Alex, I'm not an accountant so forgive my choice of words if I don't exactly get them right, but do the regulations state that Vanguard has to charge each of their funds the same percentage to cover "overhead" type functions like call centers, 1099 issuance, website, and CEO salary?

Seems like the starting point would be for Vanguard not to assess the money market funds for whatever their pervious determination of "fair share" is for call center reps and other asset administration costs shared by all the funds.
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Re: Vanguard subsidizing money market funds by $100 million

Post by alex_686 »

stan1 wrote: Wed Oct 27, 2021 9:07 am Alex, I'm not an accountant so forgive my choice of words if I don't exactly get them right, but do the regulations state that Vanguard has to charge each of their funds the same percentage to cover "overhead" type functions like call centers, 1099 issuance, website, and CEO salary?
Each fund has to pair its fair share of "shared" resources. It does not have to be the same percentage but it has to be fair and consistent across all funds.

I used to help with this when I worked in fund accounting. We would estimate the work for each fund and allocate accordingly. In the early years, before I joined, they would weigh the tax returns of each fund and allocate accordingly.

Now it is more sophisticated. Handling international equities are more expensive then domestic equites. We had international equities in both our domestic and international equity funds. Shared costs so we split the costs. International funds tend to have more international equites so are charged a higher percentage for this work.
stan1 wrote: Wed Oct 27, 2021 9:07 am Seems like the starting point would be for Vanguard not to assess the money market funds for whatever their pervious determination of "fair share" is for call center reps and other asset administration costs shared by all the funds.
You specifically can't do this. That would be cross subsidization.

The formula has to reflect the actual costs and be applied consistently across all funds. You can't favor your large fund, hot funds, new funds, or failing funds. (You can sort of - on how you set up the cost sharing formula. You can skew things But this thing is kind of written in stone. It is very very hard to change.) You can't off-load costs from one fund onto another fund behind the scenes as you are suggesting. You have to be transparent and disclose you are doing this. Same net effect, just more transparency.
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Re: Vanguard subsidizing money market funds by $100 million

Post by jdamo »

This is very interesting. I have always wondered just how Vanguard kept costs lower than others in more detail.
I mean, I /hear/understand Jack Bogle invented the mutual fund (watched lots of videos on this) and hear that if you own shares in the fund, you own part of Vanguard and are the owner..,..hence lower costs...no profit to pay other owners so to speak. Vanguard emphasizes this on their website. I think this is a major advantage with the lower costs for Vanguard, the reputation of Jack Bogle etc. This was a big reason I chose it for our retirement. You could trust it more. Do I have that correctly?

But seeing this makes me think it is more complicated behind the scenes and in the accounting. But hopefully just "how the sausage is made".
I hope Vanguard doesn't change going forward so we can benefit and still feel the same way for 10-20 years or more!
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Re: Vanguard subsidizing money market funds by $100 million

Post by alex_686 »

jdamo wrote: Wed Oct 27, 2021 12:57 pm This is very interesting. I have always wondered just how Vanguard kept costs lower than others in more detail.
I mean, I /hear/understand Jack Bogle invented the mutual fund (watched lots of videos on this) and hear that if you own shares in the fund, you own part of Vanguard and are the owner..,..hence lower costs...no profit to pay other owners so to speak. Vanguard emphasizes this on their website. I think this is a major advantage with the lower costs for Vanguard, the reputation of Jack Bogle etc. This was a big reason I chose it for our retirement. You could trust it more. Do I have that correctly?

But seeing this makes me think it is more complicated behind the scenes and in the accounting. But hopefully just "how the sausage is made".
I hope Vanguard doesn't change going forward so we can benefit and still feel the same way for 10-20 years or more!
Yes, that is Vanguard's marketing message. I know many Bogleheads buy into that line but I kind of doubt it. This is going to be a ongoing question until Vanguard discloses its financials to us, the so called owners.

Even if you do drink the marketing Kool-Aid the impact at best is going to be modest. 2nd tier stuff. Other fund shops do compete with Vanguard on price.

The 1st tier stuff is information technology and scale.

Costs are basically fixed. The bigger the fund the more you can spread these fixed costs so the lower the expense ratio. Fund size has just dramatically increased.

It is hard to describe how radically different operations are today from 30 years ago. Most of the work is about records and numbers, things that networked computers do very well. Ask me at the start of my career if we would ever see such low average expense ratios across funds I would have laughed.
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Re: Vanguard subsidizing money market funds by $100 million

Post by nisiprius »

It does seem as if the whole premise of money market mutual funds is currently tenuous.

When they were new, bank account interest rates were capped at--well, 5½% for commercial banks, 5¾ for S&L's, 6% for credit unions--when inflation was running 6% and on its way up. Everyone used checks then, and the combination of 10% quasi-interest with a pseudo-check was pretty exciting. I remember a colleague coming into lunch with a cat-that-ate-the-canary grin saying he had just found out that the IRS would accept one of those checks as payment of income tax, and in those days it took many weeks for the IRS to cash them.

Before the reforms of 2014, when Vanguard was still using the Prime Money Market Fund for settlement accounts, Vanguard was supposedly conservative in management, but the Prime Money Market Fund had a surprising percentage of overseas holdings in it. In fact this poster says that in 2015 it was 55% Yankee/Foreign.

I assume that these were and are not high-risk holdings, not like whatever it was that put the Reserve Primary Fund under in 2008, but it did give an impression that they were struggling to find things that would give a return after expenses that was not ridiculous and would compete with bank accounts.
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Re: Vanguard subsidizing money market funds by $100 million

Post by 000 »

Interesting. Thank you for pointing that out. :sharebeer
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Re: Vanguard subsidizing money market funds by $100 million

Post by toto238 »

markjk wrote: Wed Oct 27, 2021 4:50 am Keep in mind vanguard has trillions of $$ under management. Not one trillion, but something like 7 trillion worldwide. When you manage that much money, 100,000,000 is not even close to a statistically significant number. I'm sure they care, but I just want to put the numbers in perspective.

There are management functions that go into all of the funds so the costs are defendable. In the case of money markets, you nailed it when you said "... keeping interest rates so low for so long makes weird things happen." In this case the weird thing is losing money on a money market. It's nice that Vanguard is making the adjustment rather than passing the losses on to it's customers.
Just doing some back-of-the-envelope here, but Vanguard's current AUM is something like $7tr, and they collect an average of 10 basis points across all that, then their annual revenue would be something like $7billion.

So from a corporate standpoint, they're a company with probably somewhere around $5-10bil in annual revenue and losing $100m of that is a 1-2% drop in revenue. Sure it's not enough to break a company, but it's definitely enough that they would consider it a statistically significant number.
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Re: Vanguard subsidizing money market funds by $100 million

Post by EyeDee »

Alex,

I believe Vanguard may have more flexibility allocating expenses to its funds than other mutual funds.

From page 90 in John Bogle's book: "Stay the Course":

". . . 1993, when we gained approval to set the expense ratios of our individual funds, not entirely on their costs but also on the expense ratios charged by our competitors."

On page 96 in a section called "Competing on Price . . . The 1993 Proxies", Mr. Bogle talks about several things approved in the Vanguard 1993 proxy vote in the new book, including:

"Under the terms of the original Vanguard Service Agreement, we were required to apply fairly rigid standards to the allocation of costs among our funds, . . .

Following the clearance of our 1993 proxies by the SEC, we sought the approval of our shareholders to amend our service agreement to give our funds the ability to compete on price. We would continue the stern allocation methods earlier approved, but as we wrote in our 1993 proxy statement, add a provision that would allow the Vanguard funds "to provide competitive investment services at competitive prices designed to enable Vanguard to survive and grow." "
alex_686 wrote: Wed Oct 27, 2021 8:59 am
Because if expenses were reduced then the expense ratio would be reduced.

Fee waivers specifically mean that the fund sponsor is covering some of the fund's cost.

The regulations around this are very specific. Funds are supposed to be self-sufficient. Cross subsidization of funds - which transfers assets from one set of shareholders to another - is discouraged.
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