Don't panic about the unknown

By DAVID MOON, Moon Capital Management
November 11, 2007

Most of the things we fear never hurt us. It's the things we never consider that are dangerous. We don't know what we don't know. As investors, that's especially dangerous.

This became particularly obvious to me this week when I ran across some surprising information.

While most of the $2.5 trillion invested in money-market funds is invested in predictably low-risk assets like Treasury bills and certificates of deposit, as recently as this summer money-market funds with assets totaling $300 billion owned debt backed by subprime mortgages. Several of the largest money-market funds are among the group.

On June 30, money-market funds managed or marketed by Bank of America, Fidelity Investments and Morgan Stanley held $6 billion of investments containing subprime debt. One Credit Suisse Institutional money-market fund held eight percent of its assets in debt secured by subprime mortgages.

In total, money-market funds with assets of $300 billion invested in subprime debt in 2007.

Remember, money-market funds are used by most folks like savings accounts or CDs. Who would ever suspect that their presumably safe accounts would own the same types of investments that brought down multibillion-dollar Bear Stearns hedge funds or Citigroup CEO Charles Prince?

Give credit to the folks at Dreyfus. Two years ago they adopted a policy preventing any Dreyfus money-market funds from buying subprime-mortgage-backed securities. They admitted that the securities were simply too esoteric to properly evaluate.

So, should you panic?

No. First, panic is seldom helpful. Panic comes from the Greek word Panikos, which means 'a source of terror.' Terror doesn't go too well with investing.

Besides, it won't do you any good.

It's difficult to know where ' or when ' the landmines might be planted. Funds typically report their holdings only a few times a year, usually several weeks or even months after the holdings date of the filing. By then, many of the securities in the fund's portfolio have matured and been replaced. Just because a fund owned some junk bonds in June doesn't mean that it still does by the time you see its quarterly report in August.

Given the implosion in the subprime market, moreover, one hopes that any fund that didn't own any of the offending securities in June hasn't added them since then.

The biggest reason the subprime mortgage mess probably won't affect your money-market fund is because the risk is known. By the time a risk is known, investors typically adjust their behavior to avoid the potentially offensive assets. And in fact, all of the money-market funds with subprime assets protected their investors from any loss.

The lesson from this debacle is that there is always an unknown. Just because something has never happened doesn't mean that it can't happen. In a world where investors flock to funds with short-term performance improvements of hundredths of a percent, managers can be tempted to take silly risks to boost those figures. Doing so can attract billions of dollars of new assets for a firm.

And unknown risks for an investor.

David Moon is president of Moon Capital Management, a Knoxville-based investment management firm. This article originally appeared in the News Sentinel (Knoxville, TN).

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