WSJ Warns on Ultra-Short Bond Funds
The Wall Street Journal writes "The Safety and the Risk in Ultrashort Bond Funds". It says, "Ultrashort-term bond funds are a popular haven for investors looking to earn more than the near-zero yields of money-market mutual funds -- without locking up their money in a certificate of deposit or taking a lot of interest-rate risk with longer-term debt funds. The question now is how these funds will perform when interest rates eventually rise and whether the funds will see an exodus of investors. Investors pumped nearly $2.5 billion in net new cash into ultrashort bond mutual funds in the first half of 2014, boosting their assets to $64.45 billion, according to Chicago-based investment researcher Morningstar. That comes after net inflows of nearly $10.7 billion and $9.5 billion in 2013 and 2012, respectively.... Most observers expect the Federal Reserve to begin lifting short-term rates sometime next year. Ultrashort funds should be able to reinvest maturing debt at higher yields when rates rise. Still, prices could fall somewhat, unlike those of money funds, which almost always stay at a steady $1 a share. "These are not money-market funds. You could see modest losses," Ms. Bush says. Many investors lost money in the funds in the 2008 financial crisis, when bonds that the funds held defaulted or were downgraded. The average ultrashort fund lost 7.9% that year, according to Morningstar. But some funds had taken on more risk than investors expected, with holdings in longer-term debt or mortgage bonds, and some lost more than 30% of their value.... Still, by keeping interest rates artificially low, the Fed has created a scenario in which money may flood out of ultrashort funds, believes Peter Crane of Crane Data, a research firm in Westboro, Mass., that focuses on money-market funds. The Fed's aggressive approach to keeping rates very low drove "the wrong kind of people" into bond funds from safer money-market funds, he contends. "You have all these retirees who just need income," Mr. Crane says. "They don't understand the principal risk." If ultrashort funds suffer a small loss due to rising rates, these investors will be surprised and begin to sell, compounding those losses, he says."
