Charles Schwab’s YieldPlus fund was once marketed as a safe alternative to cash and was Schwab’s most popular bond fund. But Schwab stuffed mortgage-backed securities into YieldPlus’ portfolio to pump up performance and it turned toxic. YieldPlus has lost 24% of its value this year, while the average ultra-short bond fund is down just 1.9%.
Created in 1999, YieldPlus often beat bond indexes and peers and offered better yields than options such as money-market funds. Schwab brokers often advised clients with short-term certificates of deposit to switch into YieldPlus, saying the fund aimed to provide steady monthly income with limited interest rate and credit risk. But one of YieldPlus’ tactics was to focus on mortgage-backed securities, which ended up making up half of its assets. Some of those securities were supported by sub-prime loans, which started going bad last summer.
YieldPlus took an unexpected blow in November last year when Interactive Data Corp. marked down the price of some of the portfolio's debt. Schwab's problems increased when investors pulled their money out and fired their brokers. Some frustrated brokers have started giving clients the email address for Kimon Daifotis, YieldPlus’ leading manager since its inception, to send him complaints directly. As of last week, the fund's asset base had dropped to $1.5 billion from a high of $13.5 billion last year.
YieldPlus's problems are feeding on themselves. To meet redemptions, YieldPlus has had to unload bonds, potentially at fire-sale prices, tied to a variety of troubled companies, including New Century Financial, Washington Mutual, Countrywide Financial, and Bear Stearns.
Schwab blames its problems on the credit crunch and says they affect only a small part of the company, which is performing well overall. And in a backhanded no-confidence vote, none of the other Schwab funds will hold YieldPlus in their portfolio starting in April.
Investors are suing Schwab for misleading them about the YieldPlus fund but Schwab is denying the allegations. Lawsuits and the fund’s failure is a setback to Schwab’s effort to diversify beyond collecting volatile trading fees. Schwab started out providing discounted stock trading and then sold others’ mutual funds before moving into offering its own funds and advisors to build a steadier revenue stream. Service fees totaled 23% of the firm’s net revenue last year but
YieldPlus’ failure has meant lost fees YieldPlus isn’t alone in its trouble though. Similar but less popular funds like Fidelity Ultra-Short Bond Fund and SSgA Yield Plus from State Street Global Advisors have also been hurt in recent months. The funds are down 7.3% and 18% respectively this year.
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