A brief follow-up from my recent blog about the MyRA program, which was announced last month in President Obama’s State of the Union address. In the announcement, the President made the remarkable claim that this program would invest in a way which “guarantees a decent return with no risk of losing what you put in”. Which seems too good to be true. But, on closer inspection (and depending on how you interpret “decent”), it’s for real: even though the title of this blog reads like a bad internet ad, there really is an investment vehicle which pays investors a risk premium without requiring them to take any risk.
The fund in question is known as the G Fund, and is one of the investment vehicles on offer in the Federal government’s Thrift Savings Plan (TSP). This is the fund that is proposed as the basis of investment for MyRA accounts. It is an investment fund for which the Federal government guarantees the security of principal, and yet pays an interest rate greater than that available on comparable principal-guaranteed investments. Which is very nice—as long as you happen to be an employee of the Federal government eligible to participate in the TSP.
Specifically, the fund fact sheet tells us that the G Fund “is invested in short-term U.S. Treasury securities specially issued to the TSP. Payment of principal and interest is guaranteed by the U.S. Government.” Even though the specially-issued security is liquid short-term government debt, the rate of interest is NOT the same as that paid on comparable short-term government debt. Instead, the rate is “based on the weighted average yield of all outstanding Treasury notes and bonds with 4 or more years to maturity.” Ordinary investors who would like to earn the yields available on longer-term debt run the risk of loss of principal. But not the lucky participants in the G Fund; they can invest in short-term debt but earn long-term yields. Long-term yields tend to be higher, so this structure is essentially paying above-market rates on short term debt.
It seems a little odd that the government would willingly pay above-market rates on its debt. Information on 2013 is not yet posted on the TSP website, but the fund totaled $158.5 billion as of 12/31/2012, and returned 1.47% in 2012. While not exactly stellar (and debatably even “decent”), the return available to other investors in government debt with the same principal guarantee and liquidity was less than 0.10%¹. In effect, then, the government is issuing securities to the G Fund at a lower price than it could sell it to others for. The excess interest payments seem to have totaled about $2 billion in 2012. Ultimately, of course, this extra cost is borne by taxpayers.
Maybe everyone else in the investment industry is already aware of this, but it was news to me. When I straw-polled a few others about why the government might offer an above-market rate in this fund, the best anyone could think of was that perhaps it is a means of incenting individuals to increase savings. That’s an explanation which might just about make sense in the context of the MyRA. But it seems like a stretch in the context of the TSP. As always, I’d be happy to hear from any readers of this blog who can enlighten me.
Two technical comments:
Mike Sylvanus has pointed out that if investors are willing to buy and hold longer-term government debt to maturity, there is generally no risk of loss of principal. In this case, however, the capital risk has, in effect, been replaced with an illiquidity premium.
I don’t like to throw the word “guarantee” around lightly. Nothing is ever absolutely certain. In this case, I say “guarantee” because that is the word used by the President. In this context, what that means is a promise backed by the full faith and credit of the U.S. government. The default risk on that promise is very small, but is not zero.