Vanguard isn’t in the habit of waiving fees temporarily to attract new investors like many of its competitors do. However, in recent years, expense ratio limitations—don’t call them “waivers”—for its money-market funds seem to have emerged out of nowhere, with little explanation or fanfare. And now that interest rates have gone up, they’ve returned to nowhere.
In 2021, when interest rates were almost zero, it cost Vanguard more to operate funds such as Vanguard Municipal Money Market (ticker: VMSXX), Vanguard Federal Money Market Fund (VMFXX), and Vanguard Cash Reserves Federal Money Market (VMRXX) than the income generated by the debt the funds were invested in. So, in order to avoid the funds having negative yields or reducing their net asset values below the promised $1 a share—what is known in the money fund world as “breaking the buck”—Vanguard as well as many other fund companies in the same boat quietly absorbed the costs of managing them.
But now that the Federal Reserve has hiked interest rates repeatedly, taking the federal-funds rate to 4.5% on Wednesday, Vanguard money funds have sufficiently plump yields to absorb the costs and still deliver a meaningful return to investors. For example, the Vanguard Federal Money Market Fund yields 4.3%, and the Municipal Money Market yields 1.6% tax-free.
Vanguard hasn’t announced it was reducing the fee waivers, which arguably reflect a return to a more normal state of affairs now that rates are no longer near zero. Instead, one can see the shift in the funds’ annual reports.
Vanguard Municipal Money Market had the biggest change. In its annual report dated Oct. 31, 2022, its expense ratio jumped from 0.08% in fiscal 2021 to 0.13% in fiscal 2022. In a footnote, Vanguard says: “Vanguard and the board of trustees have agreed to temporarily limit certain net operating expenses in excess of the fund’s daily yield in order to maintain a zero or positive yield for the fund… The ratio of total expenses to average net assets before an expense reduction was 0.15% for 2022 and 0.15% for 2021.”
The 2022 fiscal year included the end of 2021 and start of 2022 when rates were still almost zero, so the fee reductions were actually in the first half of the year. Now, the fee is back to the full 0.15% the money fund normally charges. Vanguard’s Federal Money Market’s fees have gone from 0.09% after waivers to 0.11%.
Many money fund managers such as Fidelity and Charles Schwab also waived their fees and covered the costs of their money-market funds out of their overall profits. The problem for Vanguard is it is ostensibly run “at-cost” without any profits to cover extraneous costs. So where did the money to cover them come from?
According to an email from Vanguard spokesperson Freddy Martino: “We limited certain money-market fund expenses through the low-interest-rate cycle as we believe a viable money-market fund offering is important for clients seeking safety of principal. Importantly, these expense limitations did not impact the expense ratios of other funds.”
But that means either the money-market funds aren’t truly run at cost so Vanguard was able to lower their fees without outside help or that the extra management costs were paid some other way. Martino wouldn’t disclose more. “Given Vanguard’s setup where the [fund] shareholders are the owners of Vanguard, in effect this means that other shareholders are subsidizing owners of the money-market funds,” says Jeff DeMaso, editor of the The Independent Vanguard Adviser newsletter. “If Schwab or Fidelity is waiving money-market fees, you could say the cost is just them taking fewer profits. But in Vanguard’s case, it’s not clear who’s paying what. It’s really quite opaque.”
While Vanguard’s expense ratios for its stock index funds are low, the funds are so large that the total fees they collect in dollars are immense—$250 million in fees for the $279 billion Vanguard 500 Index fund’s combined share classes in 2021. 2022 numbers aren’t available. Vanguard’s S&P 500 ETF (VOO), which Vanguard considers a share class, has a 0.03% expense ratio while the retail mutual fund (VFINX) has a ratio of 0.14%. Vanguard’s other behemoth, the $281 billion Vanguard Total Stock Market Index (VTI), collected $527 million in fees in 2021. DeMaso points out that although expense ratios have declined at Vanguard over time, it cost only about $20 million annually to run Vanguard’s two largest index funds 30 years ago. He asks: “Does it really cost [that much] to run two index funds?”
DeMaso says Vanguard has “scraped the bottom” as far as fees go and can’t cut anymore. For the 82 different share classes of funds and ETFs that issued annual reports for the period ending Oct. 31, 2022, expense ratios fell for just two funds while 19 funds saw fees increase.
Maybe now that Vanguard Federal Money Market Fund yields 4.3% and Municipal Money Market 1.6% tax-free, investors won’t care if the true costs of managing them remain a mystery.
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