A quick note on your numbers, and then a longer discussion of reverse repos.
From fact sheet: 0.40% ER + 3.96% yield = 4.36% gross return
70% Treasuries @ 2.4% + 30% @ 7.
5% = 3.93%
(I agree with you that 2.4% is a reasonable guesstimate for 3 mo. Treasuries; I just picked up some at that rate.)
A minor point, but one needs a 9% return on the reverse repos to achieve the 4.36% gross return from the fact sheet.
Either I don't understand repurchase agreements, or the descriptions in the fund docs are weird. If the latter is true, is it something that should give anyone pause. If the former is true, then I should still personally decline to invest, as I don't believe in investing in things I don't fundamentally understand.
My understanding of a repurchase agreement is that the owner of a security, in need of cash, temporarily sells a security for the cash along with making an agreement to repurchase the security at a higher value. Typically overnight. A transaction equivalent to a collateralized loan, and a net cost to the borrower. That is, the borrowing side sells the security, to be repurchased later.
From the other party's perspective, it is a lender of cash, the buyer of a security, to be sold later with the higher sale price treated as imputed interest. That's a reverse repo.
Here's the best page I've been able to find that explains this (including 1.
5 min video):
https://www.investopedia.com/terms/r/reverserepurchaseagreement.asp
For the party selling the security (and agreeing to repurchase it in the future) it is a repurchase agreement (RP) or repo; for the party on the other end of the transaction (buying the security and agreeing to sell in the future) it is a reverse repurchase agreement (RRP) or reverse repo.
The reason I'm making such a big deal over this is that the fact sheet says that "
the fund purchases securities as either lender or borrower with the
agreement to sell them at a higher price". It's saying that whether the fund is a borrower (repurchase agreement) or a lender (reverse repo), the fund first buys and then sells. That contradicts my description of a repo (sell first, then buy), as well as Investopedia's.
This matters because it is claiming that in both repos and reverse repos, it makes money by buying the security and reselling it at a higher amount. Both sides of an agreement can't be buying first.
Let's look at the
prospectus. Under risks of a
reverse repo (p. 6), it describes a transaction where it first sells the security (one risk is being unable to timely repurchase "the securities
sold by the fund.") I think it has got repos and reverse repos backward in the risk sections, but my point here is that one of them involves the fund selling first, then repurchasing, again contradicting the fact sheet's wording.
You write about the cash flow as reducing volatility. What the prospectus says: "
Leverage Risk: Leverage risk is the risk that certain transactions of the Fund, including the Fund’s
use of reverse repurchase agreements, will give rise to leverage,
causing the Fund’s shares to be more volatile than if they had not been leveraged."
Let's stop right there. This fund is 30% in reverse repos, which it describes as leverage. Short term (overnight) or not, a 30% leveraged fund is not my idea of a low risk fund.
Reading on in the prospectus, we finally get to a full paragraph where it explains how it uses the term "reverse repurchase agreement":
In a typical reverse repurchase agreement, the Fund enters into a contract with a counterparty under which (i) the Fund sells securities for cash or cash equivalents to the counterparty, and (ii) the Fund agrees to repurchase the securities at an agreed-upon price, date and interest payment. Reverse repurchase agreements provide the Fund with a source of liquidity that can be invested elsewhere for no more than six days and/or earn income at either fixed or floating (variable) interest rates and fees. While a reverse repurchase agreement has legal characteristics of both a sale and a secured transaction, economically it functions as a loan from the counterparty to the Fund, in which the securities purchased by the counterparty serve as collateral for the loan.
So it seems that rather than generating income (as the fact sheet states) by selling back securities at a higher price, reverse repos actually incur borrowing costs for the cash the fund gets. Then how does it make money?
The correct way to answer this question is to say that it invests the cash in something that pays a higher rate than its borrowing cost. That is, after all, a conventional way of making money with borrowed cash. See, e.g. this document describing government uses of reverse repos (two basic uses - meeting short term cash flow needs, and investing in higher-yielding instruments).
http://www.gfoa.org/ensuring-safety-reverse-repurchase-agreementsInstead, here's how the fund says it makes money on this borrowed cash (from the June 30, 2018
semiannual report):
There are many existing examples that borrowers earn profit in spite of their borrowing activity for example: Banks borrow money via selling deposits and then charging high fees for additional activities related to the deposit including they charging high fees for allowing deposit buyer (the bank’s lender) to make payments (incoming and outgoing) from and to the deposit therefore, the bank actually profits a lot more than the cost it pays for the borrowing since the added commissions turn the borrowing activity into a profitable activity. In the Fund’s case, the fund charges additional fees that turn its borrowing activity into profits by charging fees for allowing its counterparties to substitute the proceeds (collateral) it receives for reasons such as substituting collateral durations.
The fees the fund is charging aren't the 7.
5% that you suggested, nor the 9% that I came up with. The semiannual statement reports that the fund is charging a 13.0% "fee rate", at least if I'm reading this part of the statement correctly.
When I see 13% being charged to counterparties for what sounds like "allowing" them to serve as the counterparty in a repurchase agreement (i.e. purchase short term Treasuries so that these securities show on their books overnight), I really wonder about the safety of these agreements.
Maybe I've read most of this wrong - I'm just picking it up as I go along. If so, as I said at the top, that just means I personally don't understand enough to invest in this. At the very least, it suggests looking deeper into the counterparties for these agreements, which amount to 30% of the assets of the fund.
I just did a fast search on the first of the two counterparties, Institutional Syndication LLC. It turns out that the other counterparty, North American Liquidity Resources LLC is the same compny, renamed. Quickly too, since the company was just organized in 2017.
It was formed in 2017 (STATX commenced operations April 13, 2017), organized in Nevada (not unusual, after Delaware, Nevada is a popular place to organize companies), run out of Staten Island, with the same address as that of its executive officer.
https://www.sec.gov/Archives/edgar/data/1721520/000172152017000004/xslFormDX01/primary_doc.xmlThe executive officer is no longer registered as an investment adviser representative, but had worked (from 1/201
5 to 11/2016) at New York Alaska ETF, which you may recognize as the management company of STATX.
https://adviserinfo.sec.gov/Individual/4522455 (click on detailed report pdf link for full report)
According to this page, he was formerly their Chief Compliance Officer and Chief Investment Officer.
https://relationshipscience.com/person/victor-amadeo-chilelli-jr-194903034None of this is intended to imply that there is anything improper with the reverse repos. It's just the information that came up when I searched on these companies and officer.
