Not sure if anyone will even see this, as this group has become virtual ghost town...

Once again, we have more examples of large losses in fixed-income funds marketed as cash surrogates. Read the M* article here.

Quite often these losses are precipitated by investments in questionable mortgage securities. Remember the "low-risk" government funds that impolded in 1994? These funds were investing in an alphabet soup of mortgage derivative securities, and ended up posting losses of 25% in that year.

Moral of the story: When looking for higher returns than a MMF, stick with high quality notes and go out a little further on the yield curve, or slightly increase your equity allocation, or do both. Rather than suffer double-digit losses in these "yield enhanced" funds, investors would have been better off in 2008 with a 20/80 portfolio, putting 20% in stocks and 80% in a high-quality short-term bond fund.

Say no to "yield plus" if you don't understand what's in the fund.

Duane

 

I read this article, and thought it was quite good. Here is a quote (emphasis added):

"This situation has, however, served as an important lesson overall. For one, it underscores the fact that there is no free lunch. With added yield comes added risk, bottom line. Moreover, it is critical to think about and watch closely the effect that a bank run can have on a fund and stay alert to signs that one might be under way."

There are many folks who scoff at a 2% money market fund or a 3% CD as a place to park cash. With that lower yield you gain lower risk. That lower risk has paid off big time recently.

Here is another quote (emphasis added):

"The selling point of these funds is greatly diminished. They were sold as cash alternatives that would provide a little more yield with a little added risk. It will be hard for investors to buy into that risk/reward promise again. The category is shrinking as a result; investors continue to redeem their shares, and SSgA Yield Plus and Evergreen Ultrashort Opportunities have liquidated in recent months. We fully expect that others will follow, considering that returns have continued to suffer."

Return is what counts, not the yield. Return is the yield you get minus any loss in value. Folks are bailing out, and this may very well be part of the deleveraging process.

Dan

I read the article last night and it made me almost sick.  I don't really understand what happened exactly to the mentioned funds.  I know the article mentioned that subprime mortgages were responsible, but almost every bond fund in the world has those.  How does one know what to look for in the list of holdings, and to be concerned about?  I have almost my entire retirement savings in American Funds short term bond fund (ASBAX) serving as a launching pad into other long term American Funds.  I parked this money in ASBAX last Spring rather than a MMF because I knew it would be there a while and MMF wasn't much better than a mattress.  I have been DCAing since May and plan to continue until I have completed my equity/income allocation, then I want to move the rest into some longer term bond funds.  In the meantime, I thought I would be pretty safe there and my NAV might suffer some if rates go up, but now I'm not so sure.  I might have that money in there for a year or two depending on what the Feds do with rates. I don't know how any of us can trust any bond funds.  

Playbook.

[quote user="playbook"]How does one know what to look for in the list of holdings, and to be concerned about?[/quote]

That is why you must read the prospectus before investing in a mutual fund, even if it is only a money market or a bond fund. There is still risk there.

As an example, compare two Vanguard money market funds (source: vanguard.com):

1. Vanguard Treasury Money Market Fund (VMPXX), 1.66% yield:

Portfolio composition
Distribution by issuer  as of 07/31/2008   Treasury Money Mkt Fund Bankers Acceptances 0.0% Certificates of Deposit 0.0% Commercial Paper 0.0% Other 0.0% U.S. Government & Agency 100.0% Yankee/Foreign 0.0% Total 100.0%

2. Vanguard Prime Money Market Fund (VMMXX), 2.16% yield: 

Portfolio composition
Distribution by issuer  as of 07/31/2008   Prime Money Mkt Fund Bankers Acceptances 2.3% Certificates of Deposit 26.5% Commercial Paper 15.3% Other 0.8% U.S. Government & Agency 55.1% Yankee/Foreign 0.0% Total 100.0%

 

So, there is a difference in risk/reward, even with money market funds.

Playbook,

I can certainly appreciate your concerns. I'm not familiar with the specific fund you mention, so cannot even make a guess as to what the fund owns. I respect American Funds in general, and don't anticipate there would be an issue with the portfolio. But due diligence is still in order, I believe.

It's a little disturbing to me that (1) some of these bond fund implosions were from very large, well-known providers, and (2) this particular issue has gotten very little press coverage. (Maybe the news is very new?)

Here is a quote from the article, which I'm posting for folks that don't care to read the entire piece...

We can't say that we saw this coming. We didn't. There were risks in these portfolios that were hard to see and had never materialized in the past, so backward-looking risk measures such as standard deviation and past losses proved unreliable. Given the near-term maturities of the bonds in the portfolio, we underestimated the damage that subprime and other low-quality bonds could cause.

Hats off to M* for covering this, and being candid about "missing" the potential problems with these funds. It still begs the question, however... what reasonable steps can the individual investor take to evaluate and manage risk in fixed-income funds?

Relying on the name of the fund is worthless, IMO. As we've seen in the past, funds with "government securities" in the name ended up being loaded with mortgage derivatives that were anything but safe. Past performance is not reliable either, as the article admits.

Owning Treasury securities directly is certainly one solution. After all, the point here is to maintain principal, not to make a killing. It's more work than just holding a bond fund or MMF, however.

Really, all I want to know about a fixed-income fund is (1) what type of securities does it own (corporates, munis, treasuries,etc), (2) what's the typical maturity, and (3) what is the breakdown of credit qualities?

I think this is an important issue, and look forward to other folks' comments here.

Duane

Thanks Chipmunk and Duane for your responses.  The problem with reviewing the prospectus is you have to really understand the composition of the securities in the fund.  For example, as Duane mentions, GSE's used to be solid.  Maybe they still are, but it wouldn't surprise me if overnight the market decided that they were nervous about them and discounted them substantially.  Same with commercial paper.  Who's to say that something couldn't blow up with those?  I called my FA this morning and we logged on to American Funds website and reviewed each of the holdings of the short term bond fund.  We especially noted the cost basis and market value of each holding.  We didn't see any security that had been discounted very much from cost basis which was encourging.  We also reviewed the percentages of its holdings: GSE's, Treasury, mortgages, assset-based, corporate, etc.  I did notice that the fund held some GMAC notes and wondered how that could be consistent with the portfolio restriction of no funds lower than 'A' rated.  If it is because they're insured, that means absoutely nothing to me now after their meltdown.  My FA is going to call American today and discuss the M* article and ask them how I can feel secure that their fund does not hold similar securities.  I don't know what else I can do.

[quote user="playbook"]

I read the article last night and it made me almost sick.  I don't really understand what happened exactly to the mentioned funds.  I know the article mentioned that subprime mortgages were responsible, but almost every bond fund in the world has those.  How does one know what to look for in the list of holdings, and to be concerned about?  I have almost my entire retirement savings in American Funds short term bond fund (ASBAX) serving as a launching pad into other long term American Funds.  I parked this money in ASBAX last Spring rather than a MMF because I knew it would be there a while and MMF wasn't much better than a mattress.  I have been DCAing since May and plan to continue until I have completed my equity/income allocation, then I want to move the rest into some longer term bond funds.  In the meantime, I thought I would be pretty safe there and my NAV might suffer some if rates go up, but now I'm not so sure.  I might have that money in there for a year or two depending on what the Feds do with rates. I don't know how any of us can trust any bond funds.  

Playbook.

[/quote]

Playbook, I hope this doesn't sound harsh as I am not intending it to be that way, but writing sometimes comes across as harsher than I intend it to. ASBAX is not a money market fund. It seems to me from all you have written that you were looking for the safety of a money market fund with ASBAX but with a higher yield. There is no such animal.

I don't have the bond expertise to be able to analyze ASABX's holdings at the level of detail I think you need, but when last I checked it was heavy on the GSE short term debt. I think tomorrow there will be less uncertainty as to the safety of that debt.

I am not sure if that debt is considered senior debt or subordinated debt. If it is considered senior debt and it is backed by the full faith and credit of the US government, ironically, ASBAX may end up being as safe as a money market fund but with a higher yield.

You are far better off than most people are in this market with such a high percentage of your wealth in ASBAX. Many have taken big hits this year.

[quote user="playbook"]  I don't know what else I can do.[/quote]

I would see what happens next week with the GSE debt and if it looks like that is a good thing for ASBAX, then I would go ahead as you had planned.

For future reference, what else you can do is just accept the fact that if you want the safety of a money market fund, you have to accept the lower returns.