Home' Trinidad and Tobago Guardian : November 15th 2015 Contents NOVEMBER 15 • 2015 www.guardian.co.tt SUNDAY BUSINESS GUARDIAN
MUTUAL FUNDS | SBG11
How upended have the rules of investing become?
How s this: Investors are talking about whether
problems in the market for corporate bonds
may spill over into stocks and drag down their
That question could have caused smirks years ago. Stocks have
historically been the riskier investment, prone to big swings,
while bonds just chugged along. But analysts say the high-yield
corporate bond market has become increasingly fragile.
Conditions may be lining up where investors one day find no
buyers for bonds when they look to sell, or at least none at a
That s led to speculation about a scenario where panic in the
high-yield bond market bleeds into stocks through a group of
mutual funds known as "hybrid" funds. They own a mix of stocks
and bonds and control more than US$1 trillion as a group.
To be sure, analysts say the likelihood of such a scenario is
remote. A lot of events would need to happen in succession. And
managers of hybrid funds say that even if a sell-off did hit the
high-yield bond market, it wouldn t have much effect on the
stock market because of the types of stocks they own.
The fact that investors are discussing the possibility shows
how much worries have risen about the market s fragility. Even
if the threat is unlikely, it s "one that in our opinion cannot be
ignored," strategists at the investment bank UBS wrote in a recent
The root of the concern
Like their name suggests, high-yield bonds pay more interest
than other bonds. That s because they carry higher risk. They re
issued by companies deemed more likely to default, at least in
the eyes of credit-rating agencies.
The worry is that many novice investors have poured into the
high-yield market. These "tourists" were desperate for higher
interest rates, given the low yields available in savings accounts
and high-quality bonds, but may not appreciate the additional
risk. If these investors panic and pour out of high-yield bonds
at the same time, prices would plummet.
What s more, investment managers say it s already getting
more difficult to find buyers for some bonds. It s a concept called
liquidity, and several reasons may be behind its decline.
Among them: regulations are forcing Wall Street banks to be
more careful with their balance sheets, and they re less willing
to be buyers of bonds.
When investors request their money back from a mutual fund,
managers have to give them cash. That means big problems for
managers facing a wave of redemptions when they re stuck in
investments they ll have trouble selling.
Hybrid mutual funds have a shade below 20 per cent of their
assets in corporate bonds. If they can t turn those into cash,
they ll sell whatever they can. That could mean the stocks that
they hold, which are among the most liquid investments in the
world, Barclays strategists wrote in a recent report. Roughly 60
per cent of hybrid funds assets are in stocks.
Ironically, high-quality stocks could be the most affected by
a sell-off in low-quality bonds.
Many hybrid funds tend to own similar kinds of stocks: big,
steady dividend payers. So this handful of stocks would feel the
brunt of any forced selling by hybrid funds. Analysts point to
such companies as JPMorgan Chase and Verizon Communica-
How likely is this to happen?
Not very. The high-yield bond market has already had a couple
scares that have driven some investors away, and it has so far
avoided an outright run on mutual funds.
Many hybrid fund managers may end up selling their stocks
to raise cash when troubles hit the high-yield bond market, says
Margie Patel. She runs mutual funds that own a mix of stocks
and bonds, including the Wells Fargo Advantage Diversified Capital
That may not hurt stocks all that much, because the ones
hybrid funds own tend to be among the largest in the world.
Microsoft, for example, is a popular investment for hybrid mutual
funds. It s also the second-biggest stock in the S&P 500 index
and worth about US$430 billion.
"I don t think the amount of equities that would be moved
would be enough to move the needle," Patel says. "If a fund sells
some Microsoft, it s not going to change the price that much."
AP's STAN CHOE
One of the most important things to know about
a mutual fund is how much it charges in fees.
Yet even though every mutual fund is required
by the SEC to report its expense ratio, one thing that many
investors never realise is that not all of the costs a mutual
fund has to pay actually show up in it.
The biggest omitted expense is the cost of trading. Just
like an individual investor, whenever a fund buys or sells
a stock, it has to pay commissions to the broker that
executes the trade.
In addition, the bid-ask spread---the difference between
what buyers are willing to pay and sellers are willing to
accept---can eat into a fund s assets if it trades frequently,
especially with stocks that have low trading volume and
In some cases, a mutual fund can be big enough that
it actually moves the market when it tries to buy a stock,
which can result in either paying a higher price or not
getting as many shares of the stock as the fund manager
These trading costs don t make it into the expense ratio,
but they can dramatically affect total return. The higher
those costs are, the harder a fund has to work just to
match the overall market s return, let alone beat it.
Many investors may look at their fund toward
the end of the year and see that one day the
share price of the fund collapses, causing them
be concerned that their fund had a really, really bad day
in the markets. Thankfully, there is no reason to panic,
as many mutual funds pay out their dividend and capital
gains earned throughout the year as distributions to their
shareholders at the year s end. Whenever this happens,
the share price of the fund drops by the same amount as
Once you realise that is happening, you might think
that it s smart to get in ahead of the distribution, as you
can bank the "gains" and reinvest the proceeds back into
the fund or elsewhere. This is actually a terrible idea,
because if you did so, you would be the on the hook for
taxes from those distributions, even though you only
owned the fund for a short period of time.
For that reason, it s generally a good idea to avoid investing
in mutual funds at the end of the year in non-tax advantaged
accounts. At the very least you should try and wait to
invest until after the fund pays out its distribution.
One thing you may be surprised to learn about
mutual funds is how different the fees can be,
even among similar funds and how much of a
difference these fees can make over the long run.
It can be difficult (or impossible) to know what
stocks they hold at any given moment. Funds
typically publish a full list of their holdings only
once per quarter. Fund managers don t want to give you
immediate information on what they re buying and selling
because they don t want to influence other investors; in
large part because their purchases and divestitures can be
sizable and can occur over a few days or weeks, not executed
in a single trade.
Generally speaking, diversity is a great thing. If
you own a wide enough array of stocks, you limit
the risk of any one investment blowing up and
depleting your overall investment. But there can be such
a thing as too much diversity.
Most large-cap mutual funds will own hundreds of
small stakes in companies. While this does a great job of
protecting downside losses, it also makes it very difficult
to realise market-smashing returns. A study by the Amer-
ican Association of Individual Investors, for instance, found
that holding as few as 25 individual stocks can reduce
diversifiable risks by 80 per cent.
For investors, the takeaway is simple: mutual funds can
help make sure you don t lose an overwhelming amount
of money on any one stock. But they can also keep you
from getting market-beating returns. For many, that s a
trade-off they are willing to make. Bloomberg
How high-yield bonds
became a source of
worry for stocks
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