Zero-Baseline Datapoint of the Day

The $9.3 billion Short Term Fund, offered as a place for schools and colleges to park their cash and get "returns slightly above U.S. Treasury bills", has now been frozen by its trustee, the stub of Wachovia which wasn't taken over by Citigroup. And it turns out not to have been particularly short-term after all: some of its investments won't mature until 2011, and investors can redeem only 33% of their holdings immediately.

The hit to investors won't be large:

The Short Term Fund is offered by Commonfund, a Wilton, Conn., nonprofit that advises colleges and schools on money management. Verne O. Sedlacek, Commonfund's chief executive, says 85% of the fund was in "high-quality" commercial paper from blue-chip issuers. The rest is largely in securities backed by assets like mortgages -- the kind of investments that are being especially shunned in the credit crisis. He estimates those are selling for about 89 cents on the dollar.

If you add that up, it comes to 98.35 cents on the dollar, before adding in any interest payments. The fund might have broken the buck on a mark-to-market basis, which would explain the three-year time frame for liquidating it, which clearly envisages holding securities to maturity rather than selling them. It seems that what's happened is that rather than giving investors back less than their original investment, the trustee has decided to simply wind down the fund altogether.

For me, this is yet another indication of how incredibly important the zero baseline is. The difference between a short-term fund gaining 1% and losing 1% is an order of magnitude greater than the difference betwen that same fund gaining 1% and gaining 3%. The latter is a question of performance, for a fund; the former is a matter of life and death.

I'd add that hedge funds have the same implicit zero baseline. People don't invest in hedge funds to outperform the S&P 500: hedge-funds are absolute-return vehicles, and if their returns are negative, that's guaranteed to result in substantial outflows, no matter what the stock market does. It's one of the problems with running a hedge fund: when times are good, your investors want you to outperform stocks. But when times are bad, they want you to outperform zero. It's a hard job, but then again you're being paid extremely well for trying to reconcile the dual benchmark.

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