The funds were supposed to be safe, holding primarily triple-A rated bonds or close to it. The problem is that they were holding the kinds of bonds that made headlines over the last few years. Their triple-A ratings were based on clever packaging by financial services firms, or they were illiquid securities. When the credit crisis hit, the bonds either did not trade or had low market values. Here are the most prominent examples: Schwab Yield Plus: This fund lost some value in the initial phase of the credit and mortgage crises, but held up reasonably well. In March 2008 when the markets hit their worst period, the fund declined from about $8.75 to $6.75. It owned a number of illiquid securities that were not trading, so they had no market value. The fund's value has continued to decline, and investors are suing Schwab. SSgA Yield Plus: This ultra-short term bond fund was supposed to be almost like a money market fund but with a higher yield. Its securities primarily were top-rated. But a high percentage of those holdings were subprime mortgage securities. When the crises hit, the values of these securities declined. The fund lost value steadily. The losses precipitated redemptions, forcing the fund to sell its securities at whatever prices it could. Losses continued to grow, and the managers were replaced. There are only a few assets left in the fund, and it probably will be liquidated at some point. Regions Morgan Keegan Select High Income: The fund for years earned higher yields by investing in less liquid and less well-known types of securities. But subprime home equity and asset-backed securities were not the place to be recently. The fund lost 68% over a year. Between declining values and redemptions, assets under management fell from $1.2 billion to $118 million. Each of these funds was offered by an established, reputable firm and had some period of success before imploding. Yet, they were under pressure to earn higher yields wherever they could find them. The managers assumed that the markets they invested in always would function and have liquidity and that the credit ratings of the securities were accurate and would not change. Investors failed to take note that the markets were paying only marginally higher yields to take greater risks. They also did not realize that despite the AAA ratings of many securities held by these funds, the markets do not pay higher yields unless there is higher risk. More recent examples are ultra-short bond funds. These are close to money market funds. The difference is that most money market funds have average maturities of one year or less. Many keep their average maturities less than 90 days. Ultrashort bond funds have average maturities up to two years, so their share prices normally fluctuate by a penny or two per share over the short-term. Recently, however, inflation and signs that the Fed is done lowering short-term rates caused market short-term rates to rise. That reduced the value of short-term bonds. The change has not been dramatic yet. But it has taken away the marginally higher yields the funds offered and likely will get worse before this cycle is over. Over the last few years we warned consistently that income investors were not being paid for taking the additional risk outside of short-term treasury bonds and eventually said it was time to hunker down in the safety of money market funds and wait for the markets to return to normal levels. July 2008.
© 2003 - 2012 Retirement Watch, L.L.C.
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