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Jewish World Review Feb. 14, 2008 8 Adar I 5768 Dirty little secret of some funds may be haunting By Gail Marks Jarvis
http://www.JewishWorldReview.com | (MCT) Take a look at your bond mutual funds. Do they make you feel cozy - insulated from the mortgage mess? Looks may be deceiving. And mutual fund regulators at the Securities and Exchange Commission are concerned that you might not be holding onto the mild-mannered investments that you think you are. The SEC is preparing steps that could cause some funds to alter the value of some bonds in their funds. Ultimately, it could mean that a seemingly stable fund would, all of a sudden, take a dive. Although your fund manager might not have indicated to you that there are sickly mortgage-related bonds in your fund, they could be buried there nevertheless, threatening the value of your fund. And the SEC is updating guidelines about what you should be told so the consequences of bad bond investments don't sneak up on you. At present, nearly worthless bonds, tainted by the mortgage mess, are sitting in pension funds, bank holdings and mutual funds while managers wait for a better day to sell them. But institutions are so afraid of some mortgage-related bonds that they aren't buying them. And like anything else, when you can't find a buyer, the price plunges. Douglas Scheidt, SEC investment management division associate director, said he does not know how many funds might be holding troubled mortgage-related bonds that haven't been adequately revealed to investors. A few funds have reported bond problems and suffered large losses. Regions Morgan Keegan Select High Income, for example, lost 55 percent of its value after it disclosed a 15 percent stake in mortgage-related bonds. Investors fled the fund. That, of course, caused the value to drop because people take their money with them. Some fund managers are hoping that if they are quiet for a while, investors will recover their courage and buy the tainted bonds, and then values will start to climb. But that's not the way mutual funds are supposed to operate. There isn't supposed to be wishful thinking involved, and the SEC plans to issue what it calls guidance before the end of this quarter so funds are more forthcoming, Scheidt said. Funds are supposed to take their lumps at the end of each day, and mark down the prices on each bond to that day's market price - or the price that someone would pay to buy each bond. The process is called "marking to market." Together, the prices on all the bonds in a mutual fund add up to the net asset value. The idea is to make sure you pay a fair price when you buy the fund and don't get either too much or too little money back when you leave a fund or decide to sell some of your shares. It's a little like going to the store to buy a box of corn flakes. If someone had shaken the box and the flakes were fluffed up and filled the box, it might seem full when you picked it up off the shelf. But if you later discovered that the corn flake box didn't really hold the 10 ounces reflected on the label, you would realize you didn't get everything you intended to buy. Scheidt said he is concerned because he thinks some mutual funds are using "stale prices" on some of the mortgage-related bonds, which are prices derived from a call to a broker weeks earlier. In the recent market, with few, if any, buyers interested in mortgage-related bonds, finding the appropriate price is tricky. A price that's weeks old could be greatly inflated. Likewise, prices can be artificially low, set off by the urgent need by a fund or pension fund to sell it because it no longer fits its safety standards. Funds do not want to use fire-sale prices, or the very low prices that desperate sellers accept when they are forced to sell a bond, Scheidt said. They don't think that reflects what the bond is actually worth. But Scheidt said, "The question of the day is: What's the right price?" The bonds are in limbo because investors won't make investments if they have no idea what price is fair. And the buzzword for what is needed to help fix the problem is "transparency." Regulators and investors alike don't know the value of the mortgage-related bonds in part because there isn't detailed information available about the collateral - the home mortgages that must be paid in order to provide money to bond investors. Although it may be hard to believe, the collateral, or pools of mortgages, are largely a mystery. And careful investors shun bonds when they can't be sure there is enough collateral to compensate them. In the case of these bonds, investors lack basic details such as whether homeowners have paid their most recent house payment on time, said Richard Field, founder of TYI LLC, a Needham, Mass., firm that has developed a means of gathering and standardizing the data. At a conference of the American Securitization Forum in Las Vegas last week, Federal Reserve Governor Randall Kroszner said investors haven't understood the loans that are the key to the bonds. And the forum, which involves the players that are involved in packaging loans into bonds, is setting up a task force to consider how to reveal more to investors. "There are a bunch of ideas about how to break the paralysis," Scheidt said. "If pools provided more data on the collateral, sophisticated investors would be more knowledgeable on the risk and less skittish. It could thaw the ice and bring buyers." Every weekday JewishWorldReview.com publishes what many in the media and Washington consider "must-reading". Sign up for the daily JWR update. It's free. Just click here. Gail Marks Jarvis is a personal finance columnist for the Chicago Tribune and author of "Saving for Retirement without Living Like a Pauper or Winning the Lottery." Comment by clicking here.
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