Troubles in Bond Fund Market
During times of market turmoil, investments such as bond funds - with relatively low volatility and consistent interest payments - are supposed to be a safe, secure place to park cash. No more.
The downturn in the economy, along with fears of more fallout from the subprime mortgage debacle, has made this once-safe haven of the financial world a target for fiscal despair.
One-fifth of all investment-grade U.S. taxable bond funds tracked by Morningstar Inc. have been losing money since the start of the year through April 4, according to an April 8 article in the Wall Street Journal. Bond funds that invested heavily in mortgage securities suffered the most significant losses. The Regions Morgan Keegan Select Intermediate Bond fund was down 44 percent since January and 72 percent for the past year. Other funds to post major losses: the State Street Global Advisors Yield Plus and Schwab YieldPlus, which fell 18 percent and 23 percent, respectively, since the start of 2008.
There are some bright spots, however. The Lehman Brothers U.S. Aggregate bond index, which tracks taxable bonds - including Treasury notes, corporate and various mortgage securities - is up nearly 2.3 percent as of April 4, according to the Wall Street Journal article.
Even the more successful funds that invest in inflation-protected Treasury securities could soon face troubles should interest rates go up. If that happens, the price of Treasury bonds likely will drop significantly.
As the Wall Street Journal article points out, bond mutual funds have become more complex in recent years. Previously, investment-grade funds invested in standard bonds issued by the government and well-established companies that routinely have large earnings and no extensive liabilities.
Recently, though, bond funds have added new investment dimensions to their portfolios, including mortgage securities issued by private financial institutions. And some of these mortgage securities were based on subprime loans. As the headlines cite daily, the default rate for subprime borrowers has skyrocketed in the past year, creating a tremendous sell-off of mortgage securities. As a result, a number of bond funds have been caught in this fall-out.
Where To Go From Here
The fall-out also has made investors in bond funds more aware of how difficult it is to actually determine if their funds have investments in low-quality mortgage securities and other asset-backed products. While some funds may disclose they own asset-backed securities, they may fail to say whether they are backed by mortgages, according to the Wall Street Journal article.
Nor can investors rely on a bond fund's credit quality to determine its risks. Both the State Street Global Advisors Fund and the Schwab YieldPlus Fund showed average credit ratings of double-A or more, according to their disclosure statements. Yet, both had sizable losses in the past year.
The idea that bond funds were a safe-haven investment, immune to the credit crunch that has roiled nearly every other corner of the financial markets, no longer holds true. If there is a lesson to be learned for investors, it's that there are no “safe-haven” investments. Low risk means risk nonetheless.
If anything, investors are well advised to take a time out for an investment reality check. Stay on top of your portfolio, do the research to determine if a bond fund is safe and, above all, be an active participant when re-evaluating investment strategies with a financial advisor.
Our affiliation of lawyers is actively involved in advising individual and institutional investors in evaluating their legal options when confronted with subprime and other mortgage-related investment losses.
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