September 9, 2008
By Gail MarksJarvis
You should expect to get hurt in bear markets if you are playing around in stocks.
But perhaps the cruelest of realities in the recent financial mess has been that even what are supposed to be “pretty safe” investments haven’t been safe enough.
Ultrashort bond funds, which investors often use to park cash for safekeeping, have not been the conservative investments they envisioned.
Over the past year, with bum mortgages poisoning certain bonds and bond funds, ultrashort bond funds have been infected. In fact, those that have been poisoned the worst have lost between 10 percent and 30 percent, according to Morningstar Inc. data. Overall, the category is down 2.7 percent this year alone, according to Morningstar.
“The ultrashort-term bond category has taken a massive blow,” Morningstar director of fund analysis Karen Dolan said in a recent report. It has been so serious, she said, “Recovery for many of the hardest-hit funds falls somewhere in the range of doubtful to impossible.”
It didn’t help investors to stick with the largest, most well-known firms, which is sometimes considered a good defense from disaster. Instead, two of the hardest-hit funds have been the Fidelity Ultra-Short Bond and the Schwab YieldPlus.
Securities law firm Klayman & Toskes recently filed an NASD arbitration claim against Schwab on behalf of investors who claimed they purchased the fund as an alternative to a money market fund so they could obtain income with little risk.
Many financial advisers use short-term bond funds for clients because they often yield slightly more than money market funds. Because they invest in bonds that mature quickly, they are perceived as less risky than funds that buy bonds that might not mature for three years or more. The longer a bond’s maturity, the more chance that surprises can come up, including the risk that interest rates can change, eroding the value of the bond.
Asset-backed securities implode
But a number of funds were holding what are called asset-backed securities, backed by subprime loans, other mortgages and student loans. Such investments used to be considered safe, but analysts severely underestimated what could happen to them in a housing crash and panicky market. As the housing market slumped, the bonds lost value. And as investors became increasingly nervous, they lost their appetite for the bonds, and the prices plunged more.
Mutual funds have to record the value of their holdings at the end of the day, so the plunging securities showed up dramatically in fund values. As anxious investors decided to bail out of the funds, the managers had to sell securities to raise cash to pay people leaving.
Although funds took actions to stop the damage, it was not adequate to save investors from serious losses.
In a recent report, Morningstar analyst Miriam Sjoblom said that Fidelity team’s “missteps have proved costly” to investors in the Fidelity Ultra-Short Bond fund. As conditions failed to improve with investments in the fund, she said, the manager overhauled the portfolio, flushing out the fund’s more volatile holdings.
Now, she says, the fund has “steadied.” About 85 percent was recently sitting in cash, with only 10 percent in asset-backed and mortgage bonds.
Although Sjoblom said the fund managers “vetted” those holdings, and the revised contents should deliver a “milder ride” in the future, the fund is down 10 percent over the past 12 months.
“Recent woes cause us to question its overall usefulness,” she said.
Some funds have been in such bad shape that fund companies have liquidated them. Dolan notes that SSgA Yield Plus and Evergreen Ultrashort Opportunities have been liquidated, and, “We fully expect that others will follow.”
Dolan said investors who want the stability that they had thought would come from an ultrashort bond fund “should look elsewhere at this point.”
Among safer alternatives would be money market funds known as Treasury-only money market funds. Money market funds, which go beyond safe U.S. Treasury investing, have experienced problems in the mortgage mess, too, but have historically had a policy of making sure that investors don’t lose money. If you have a dollar in a money market fund, the firm makes sure you get it back.
That, of course, is not a promise. For investors who want assurances, consider investing up to $100,000 in banks that are insured by the Federal Deposit Insurance Corp. or investing in U.S. Treasury bonds.