Ultra Short-Term Bond Funds Can Lead Investors Astray

Safe havens in the investing world have become an oxymoron. Amid the dismantling of Wall Street and other centers of financial engineering, investments once characterized as “cash alternatives” are vanishing overnight. What investors thought was a safe, secure liquid-as-cash investment is no more.

Case in point: Ultra short bond funds. Ultra short bond funds are mutual funds that typically invest in fixed-income securities with short maturity dates before they become due for payment. Like other bond funds, ultra short bond funds can invest in a wide range of securities, from corporate debt, to government securities, to mortgage-backed securities and other asset-backed securities.

Often described as a cash-alternative investment, ultra short bond funds are attractive to investors who want higher yields than traditional cash accounts with only marginally higher risk. That’s the theory, anyway. In the past year, the average ultra short bond fund has lost about 5% versus a 2.6% average gain for taxable money funds. And, in some cases, investors have seen their ultra short bond fund investments obliterated entirely.

The Schwab YieldPlus Fund is one example. Marketed by Charles Schwab as an alternative to cash, the one-time $14 billion fund has seen its value plummet, falling nearly 34% in 2008 alone. Another ultra short bond fund to implode this year is Evergreen Investments Ultra Short Opportunities Fund. That ultra short bond fund has lost than 20% of its value and was deemed the second-worst performing - behind the Schwab YieldPlus Fund - of the ultra-short bond funds tracked by Morningstar Inc.

So how did it go so wrong for these supposed “cash-like” investments? In a word: subprime.

In addition to mischaracterizing their funds and failing to offer adequate explanations of their potential risks, the companies behind the Schwab YieldPlus Fund and the Evergreen Ultra Short Opportunities Fund apparently omitted key information about what their managers really were investing in. In short, the words, subprime or high concentrations of mortgage-related investments, came up missing entirely at the time the funds were marketed and sold to investors.

As a result, investments made in risky illiquid mortgage-backed securities caused many ultra short bond funds to tank in value following the onset of the subprime crisis. Making the carnage even worse was the fact that the funds’ managers had to get rid of the toxic securities at fire-sale prices in order to come up with the cash for investors wanting to bail out.

The bottom line: With the country’s financial crisis playing out before us, safe, conservative investments are becoming harder and harder to find. One thing is for sure: In today’s market, investors who are considering ultra short bond funds may want to think long and hard. Lessons of the past year concerning fallen funds like the Schwab YieldPlus Fund, Evergreen Investments Ultra Short Opportunities Fund and others serve as definitive proof that ultra short in no way means ultra safe.

Our affiliation of securities 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.

This entry was posted on Friday, October 17th, 2008 at 10:37 amand is filed under Bond Funds, Charles Schwab, Fidelity, Mortgage Backed Securities. You can follow any responses to this entry through the RSS 2.0 feed. You can skip to the end and leave a response. Pinging is currently not allowed.