Subprime woes claim a category long thought to be low-risk.
So much for money market substitutes. There have been a number of articles over the years about using short- or ultrashort-term bonds as money market substitutes. Yields on money market funds are typically low so it's understandable that you might want to boost income by moving to ultrashort- or short-term bond funds, which sometimes have a higher yield.
However, the subprime mess may forever dispel investors of that notion. Ultrashort is supposed to be the most conservative, low-risk bond fund around, yet a number of funds are in the red for the trailing four months and even the year. Consider that ultrashort has been about the worst place to be for the past four weeks. Through Friday, the average ultrashort fund is down 0.36%, versus gains of 0.37% for short-term bond funds, 0.37% for intermediate, and 0.16% for long bond funds. Only high-yield, emerging markets, and bank-loan funds have fared worse.
The category truly has the lowest risk when it comes to interest-rate risk as its funds have the lowest duration of any taxable funds around. We define ultrashort bond funds as those with durations of less than a year. Because they are naturally owned by investors with pretty short-time horizons most of the funds don't take on much credit risk. However, ultrashort bond funds are allowed to take on more credit risk than money market funds, and some do so. Moreover much of the subprime bonds these funds own are actually rated AA or AAA, so the risks didn't seem like all that much until now.
Usually ultrashort funds' returns are bunched within a few basis points but the subprime problems have scattered them. At one end, the usually steady SSgA Yield Plus
SSgA has been done in by some subprime securities. Although none of the fund's subprime holdings were part of the rating agencies' big downgrades, the fund has been hard-hit. Redemptions (roughly 15% of assets) probably made things worse because they had to sell into a market in which no one wants to touch subprime even if it looks okay. The fund's expenses have risen in recent years, so I wonder if management felt the need to stretch for yield in order to compensate for raising costs. In any case, the fund's four-week return is a huge 270 basis points worse than the next-hardest-hit ultrashort fund.
SSgA does have prominent company in the red. Fidelity Advisor Ultra Short Bond A
The next-worse loss belongs to PIMCO Floating Income
All told there are 22 funds in the red for the trailing four weeks including such prominent names as Dreyfus, Schwab, JPMorgan, and MetWest. Kudos to the firms whose funds are still comfortably in the black including AMF, TCW, and PIMCO Short-Term Bond
In 2002, we saw something somewhat similar when markets got panicky about corporate bonds and funds that seemed pretty conservative got tagged. To be sure ultrashort fared much better then, but there were funds such as MetWest Low Duration
Some subprime debt has quite rightly been punished but it's hard to say if the higher end will rebound--not to mention a wide variety of bonds that have been hurt by the drop in liquidity and follow-on effects from subprime even though they aren't subprime or even mortgage-related in some cases.
So, I don't know if you should hold on if you have an ultrashort bond fund that's in the red. I do know that this is proof they make lousy money market substitutes. If what you really need is a money market where the principal value never wavers, then reintroduce yourself to money markets.