Vanguard Shrinks Its Treasury Fund Offerings

Treasury securities became a parking lot for cash during the financial crisis. Investors in search of a safe haven poured money into Treasury IOUs of all maturities, pushing down yields of bonds to 2% and of super-short-term Treasury bills to virtually nothing. As investors have regained their appetite for risk, some of that panic-buying has started to unwind, particularly on the long end of the yield curve.

However, the short end of the curve, which measures yields against maturities, is another story -- one that's posing problems for some fund companies. Citing a shortage of short-term Treasury debt relative to demand, Vanguard Group recently closed its Federal Money Market Fund (symbol VMFXX) to new investors and limits current investors to a $10,000 daily investment limit. In addition, Vanguard plans to merge two other, already-closed funds -- Treasury Money Market (VMPXX) and Admiral Treasury Money Market (VUSXX) -- on August 11.

The moves could cause problems for investors of modest means. Daniel Wiener, editor of the Independent Adviser for Vanguard Investors newsletter, raises the possibility that customers of limited means may never again be able to invest in a Vanguard money fund that invests in government-backed debt. Before it shut, Treasury Money Market required a $3,000 initial minimum investment; Admiral required $50,000. If and when the merged fund reopens, it will probably carry Admiral's $50,000 minimum, says Weiner: "Presumably Vanguard could, down the road, open a new, lower-minimum Treasury money fund, but for now, small investors will not have that choice on their Vanguard menu."

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Vanguard loyalists have a low-minimum alternative that's nearly as good as a short-term Treasury fund. Vanguard Prime Money Market (VMMXX) maintains a high-quality portfolio, with 58% of its assets in government-backed debt at last report. The fund, which requires $3,000 to start, currently yields 0.38%.

Short-term yields are so low today that government money funds are barely earning enough income to cover their expenses. As of June 9, for instance, one-month Treasury bills yielded just 0.08% and three-month bills yielded 0.18%. Vanguard, which is known for its low expenses, charges 0.15% of assets to operate its Admiral Treasury Money Market. The fund's earnings from investments, in other words, barely cover its expenses, if that. It's no wonder that Vanguard doesn't want to take any new money, at least not for now.

Meanwhile, bond powerhouse Pimco is bolstering its menu of Treasury funds. It recently launched an exchange-traded fund that invests in short-term Treasuries. Pimco 1-3 Year U.S. Treasury Index (TUZ) tracks the Merrill Lynch 13 Year U.S. Treasury index. It aims to deliver yields that are slightly higher than those of Treasury bills and government money-market funds. Pimco is currently waiving some fees to keep the fund's expense ratio at a rock-bottom 0.09% a year. If nothing changes when the waiver expires in October 2011, the ETF's expense ratio will rise to 0.15%.

Why would Pimco, home to legendary bond guru Bill Gross, launch a short-term Treasury ETF when the firm has a successful franchise in actively managed funds? "It's topical," says Don Suskind, product manager for Pimco's ETFs. "Our current investment outlook does reflect favorably on short-term bonds."

Pimco plans to launch six more ETFs: Three will invest in medium- and long-term Treasuries, and three will buy Treasury inflation-protected securities, or TIPS.