Sunday, October 12, 2008

Now bond funds are tanking along with stocks; are they no longer safe for "conservative portolios" during this crisis?


One of the most disturbing aspects of the current slide for retired investors is that corporate bond prices are sliding down right along with stocks. This contradicts previous advice that “conservative” portfolios for those in or close to retirement should emphasize bonds (other than junk bonds). We’re left with cash-like assets as the only investments that protect principal.

The story appears in the Weekend Wall Street Journal in the “Personal Finance: Money & Investing” page, B1, and is by Liz Rappaport. The title is “Corporate bonds slide along with stocks: Investor deleveraging hits junk, higher-grade debt: market points to recession”. The link is here.

Much of the problem seems to result from pressures on bond funds to come up with settlement cash, as with stocks.

What’s not clear is the effect of the Lehman Brothers auction. Creditors will demand 91% redemption from the default swaps. Will some of this money pay back the bond funds soon? Or are these funds further exposed? Blackrock Global Allocation MDLOX has holding classes like this “Swp: Gbp 4.855000 05/07/2010” even though the percentages of the total fund are small. Are these swaps that they have to pay, or swaps that they are owed, or unrelated? Can someone comment? (Go to Yahoo! go to the security symbol and look at “Holdings” for any such fund). PIMCO (“PTTCX”) bond funds, on the other hand, show a lot of Fannie Mae at 5.5% but I thought these were guaranteed by Federal seizure around Sept. 8. PIMCO has also deteriorated.

Blackrock Global's prospectus discusses credit default swaps on p 13, link here. It's not immediately clear if what shows in Yahoo! was "bought" by the fund (and therefore owed if there is a default) or "sold" (and therefore a liability). It would appear (from the language there) that the liability could affect the value of the fund outside the valuation given to any swaps themselves. I hope someone understands this.

I do appreciate comments from those who understand what is going on relative to what “average individual investors” are likely to have in programs like Merrill Lynch CMA. Blackrock seems like one of the leading companies, and was on the Treasury Department’s lists of possible contractors to manage the bailout.

Back in Feb. 2008, Lewis Braham wrote a Business Week article, "Credit Default Swaps: Is Your Fund at Risk?" link here. A more recent (and candid) assessment appears in Business Week Sept. 25, by Ben Levisohn, "Are You Exposed to Credit Default Swaps? They're likely in your portfolio. Here's what that means" link here.

SmartMoney has an explanation that tends so suggest that SEC rules would allow the entire bond fund value (exactly) to be at risk in a credit default swap arrangement. It says also "Disclosure about CDS is still an industry problem. Shareholders looking for clarity on a fund's derivative holdings won't find it in fund reports." The link is here.

Again, the immediate danger seems to be, in light of the Lehman Brothers liquidation, nobody knows if (or which of0 any major funds could be seriously impacted by calls on default swaps, even in the next few days.

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