Monday November 19, 2007
Check Your Mortgage Exposure
I recently met an investor who expressed perplexity about the country’s mortgage crisis. “How on earth,” the lady asked, “could leaders of the country’s biggest financial institutions have been so asleep at the wheel to permit their groups to take on such great mortgage risk?”
Good question.
But it’s not just the portfolios of a handful of brokerage firms, banks and hedge funds that are laced with risky mortgage-backed paper. Your portfolio might also hold surprise doses of risky debt and dangers.
Earlier this month, General Electric alerted clients that its Trust Enhanced Cash Trust fund — a money market fund — was sustaining losses. GE offered to redeem client holdings at 96 cents on the dollar and closed the fund to new money. In an explanation to analysts, GE said that its move was prompted by “extreme conditions in the credit markets including liquidity concerns and value dislocations”.
Bloomberg reports that Bank of America (and specifically its asset management arm “Columbia Management”) SunTrust, Wachovia (“Evergreen Investment Management”) and others are either adding offset money or considering such additions to cushion their funds against possible mortgage-backed debt losses.
The injections may exceed $700 million. And in a move perhaps linked to these developments, Bank of America’s “Columbia Management Group” announced a new Senior Portfolio Manager for its money market funds and new Chief Investment Officer yesterday. The group’s “Nations Cash Reserves Fund” is one of the industry’s largest money market offerings.
I’ve spent time on-line trying to obtain details about the underlying content of the money market funds of these asset managers. Often (but not always) the data is stale or imprecise as to the amounts and quality of the mortgage content.
That means that you — more often than not — have to call a company’s “customer service line“ and ask for content specifics.
But it’s important to do so. Because if you believe that all bond and money market funds are “just about riskless” — think again!
Of course, “mortgage-backed securities” are more often than not investments with acceptable (and sometimes attractive) risk and quality characteristics. High “mortgage-back” content is certainly not, in and of itself, a symptom of high risk or cause for alarm.
Let me repeat: high “mortgage-backed” content is not, in itself, a distress signal.
Nevertheless, the underlying mortgage content of many funds leaves today’s investors in a quandary. Which bond and money market funds are, after all, low-risk? Which ones alternatively have hybrid mortgage or adjustable-rate mortgage content that may, indeed, be problematic? And how many asset management groups are likely to be as forthcoming as General Electric to warn customers about the risk and pricing issues?
Be sure to check out the underlying content of your bond and money-market holdings. Visit morningstar.com, enter your fund’s name, and click the “Portfolio” link at the far left. For many funds, the site will tell you the mortgage content (if any) of your funds. It also breaks down underlying bond content by rating. So you can easily see the percentage of “junk bonds” in your fund — that is, bonds rated “BB” or lower.
If your fund is covered by Morningstar and has mortgage-backed content, Morningstar distinguishes between different kinds. “Pass-through” mortgage-backed securities include conventional mortgages and mortgages backed by Freddie Mac and Freddie Mae (two quasi-government agencies). They have somewhat better risk characteristics. They do not, however, carry any de facto government guarantee.
On the other hand, higher-risk subprime assets are prevalent in some funds — often, I’m afraid, without Morningstar’s coverage and perhaps without realistic pricing. You may not see any content problem in a fund’s current valuation or on-line description! Since (a) there is little demand right now for distressed-mortgage assets and (b) banks and portfolios managers are reluctant to re-price or down-price and take a hit, you may hold a fund with both liquidity and pricing issues.
Be sure to check out the content of your bond and money market funds. Use Morningstar and also call your fund manager. Ask what the fund‘s exposure is to mortgage-backed securities and any illiquid “SIVs” [“structured investment vehicles”]. Take steps today to determine whether your bond and money-market positions entail unwanted risk.
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