Memphis-based Regions Morgan Keegan (RMK) may advertise “exceptional due diligence” as what sets it apart from competitors, but investors in six collapsed RMK mutual funds would say otherwise.
The RMK funds, including the RMK Select Intermediate Bond Fund (MKIBX) and the Select High Income Fund (MKHIX), are some of the bond industry’s biggest failures on record. Some of the RMK funds have plummeted more than 80% in value since mid-2007 thanks to the actions of former manager James Kelsoe, who invested a huge chunk of the funds’ portfolios in toxic subprime paper.
A recently released paper by the Securities Litigation and Consulting Group (SLCG) sheds new light on how complex structured investment deals like those associated with the RMK funds have enabled Wall Street to create risky securities backed by even more risky securities. While the investment innovations may provide additional investing opportunities, they also present a dangerous downside. Their sheer complexity makes it difficult, if not impossible, for investors to fully comprehend the substantial risks they are unwittingly taking on.
Case in point: six Morgan Keegan bond funds - four closed-end funds (RMH, RHY, RMA and RSF) and two open-end funds (MKHIX and MKIBX) - that cost investors $2 billion in losses. Investors in these funds never knew that the funds’ holdings included hundreds of low-priority tranches of structured finance deals - deals that included high-risk collateralized debt obligations (CDOs), collateralized mortgage obligations (CMOs), and asset-backed securities (ABS).
In almost every case, the asset-backed securities held by the RMK funds were virtually always the most risky tranches in asset-backed securities deals, according to the SLCG paper. As an example, SLCG examined the portfolio of the RMK Multi-Sector High Income Fund (RHY), and identified whether the tranches held were senior or subordinated for 147 of its 161 asset and mortgage-backed securities. Only nine of the 147 tranches were senior; 138 of the 147 were subordinated.
Morgan Keegan always has been keen on letting investors know that it performs “in-depth and detailed evaluations” on all of the bond funds recommended to retail clients. The company’s so-called due diligence is supposedly one of the hallmarks of its operations. If that were the case, however, any evaluation that had been performed on the six RMK bond funds would have uncovered RMK’s misrepresentation of risky asset-backed securities as corporate bonds and preferred stocks, as well as disclosed the highly leveraged credit risk in the low-priority asset-backed securities held in the funds.
The bottom line: The catastrophic losses suffered by investors in the RMK funds did not have to happen. From the outset, Morgan Keegan failed to fully or accurately inform investors in its bond funds of the risks regarding the subordinated tranches that the funds held. Only after massive losses occurred did RMK reveal this critical detail.
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