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Be careful where you look for yield

The drive for higher yields is pushing some money market funds and, now, some bond funds to look for better returns in dangerous places.

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The result is that some ultra short-term bond funds have had spectacular losses, compared with other funds in their category, and investors who were looking for better gains with minimal risk are left holding the bag.

Charles Schwab customers are the latest to experience this. Both the Schwab YieldPlus - Investor Shares (SWYPX) and the Schwab YieldPlus - Select Shares (SWYSX) are down approximately 20 percent year-to-date. Compare that with the 1.4 percent year-to-date average loss for the 78 ultra short-term bond funds tracked by Lipper.

Consumers who invest in money market funds that go astray can, almost certainly, assume that their account will be reimbursed. While there is no government guarantee that you'll get a dollar back for every dollar invested, money market funds are regulated and are supposed to invest in a limited array of what are considered to be the safest securities, and no consumer has ever lost money in a money market fund.

Bond fund investors don't have that security. Bond funds aren't subject to the same investment restrictions, and fund managers take additional risk in an effort to attain higher yields than those typically produced by money funds.

Schwab spokeswoman Sondra Harris says investors shouldn't expect to be reimbursed for their losses. "The deal with making investors whole is when there has been some kind of error on the part of broker-dealers. That was not the case there. This is a traditional mutual fund and it would be treated the same as when an investor loses money in any mutual fund. The broker-dealer doesn't make up your losses. You read the prospectus and presumably know it's a variable fund."

A class taking action
Apparently, enough investors have come forward for a Seattle law firm to file a proposed class-action lawsuit against Schwab. Attorneys representing the plaintiffs say customers were given misleading information in advertisements, on the Web site and in the prospectus.

The lawsuit alleges that Schwab advertised the funds as a safe alternative to money market funds that preserve principal, that the funds provide higher yields with only marginally higher risk, and that the funds invest primarily in investment-grade bonds.

Steve Berman, an attorney with Hagens Berman Sobol Shapiro LLC, which is handling the class-action suit, says many customers have contacted the firm. "We've gotten 257 responses, which is unheard of in these cases, and uniformly all of the folks are saying that they were told by their advisers and/or they read the prospectus as saying that this was nearly as safe as cash."

Schwab's Harris says the company believes that the prospectus met legal requirements and that the company will fight the lawsuit.

"These lawsuits are ridiculous," says Peter Crane, president and publisher of Money Fund Intelligence. "That you can lose money in the market may be a news flash to some people. We've had lawyer overkill for decades. The reason people don't read the prospectus is because the fund companies live in paranoia of lawsuits. There's disclosure till the cows come home."

Herb Hopwood, president of Hopwood Financial in Great Falls, Va., says that a quick look at the investment categories that make up the Schwab funds -- information available in the prospectus, on Morningstar and other personal finance Web sites -- can put risk in perspective. Hopwood compared Schwab's YieldPlus Investor fund with Goldman Sachs Ultra Short Duration Government fund (GSAMX), which has had a year-to-date loss of only 0.17 percent.

"The portfolio tells you everything," says Hopwood.

What's in the portfolio
Holding Schwab YieldPlus Investor Fund (SWYPX) Goldman Sachs Ultra-Short Duration Government Fund (GSAMX)
U.S. Government bonds
Mortgage Pass-Thru
Mortgage CMO
Source: Morningstar
 
 
Next: "These ... are not as liquid, and then you compound it by the risk ..."
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