Monday, May 12, 2008

Schwab Yield Plus and Fidelity Ultra-Short - Putting Cash in the Wrong "Safe" Place

Investors who've placed their money in ultra-short-duration bond funds for the past year are feeling the pain now. For some funds, the damages are far worse: SSgA Yield Plus (SSYPX) is down nearly 30 percent, Schwab YieldPlus (SWYPX) lost more than 28 percent of its value and Fidelity Ultra-Short Bond (FUSFX) has taken a 12.8 percent dive.

How did these supposedly "safe" funds turn out to be such losers?

Blame it on the sub-prime credit crisis. Ultra-short funds typically hold a big chunk of sub-prime asset-backed securities so when the housing market tanked, the value of the funds went with them. That prompted investors to sell their funds in mass, bringing prices down even further. Managers have no choice but to meet redemption requests and face the losses. They won't be able to ride it out and hope for the fund to mature in a few months and make it whole again.

Before the credit crisis, rating agencies routinely gave appropriate ratings to these securities and many managers considered them safe enough to fit into a risk-averse fund like an ultra-short and gain some extra returns.

Investors who realize the problem they have on their hands now could face two possible scenarios. If the fund can avoid selling securities, the investor can hope that with time the fund can stay out of foreclosure or default and come out whole again. Or, there is a good chance that other shareholders will bail out and leave the hopeful ones to face the mess.

Of course, another scenario is that a fund company could bail out too. State Street Global Advisors has already announced plans to liquidate SSgA Yield Plus.

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