Why Mutual Fund Guardians Are Failing

“Even the most independent and conscientious board members have no real leverage in negotiating with managers over fees,” says John Morley, a University of Virginia Law School professor.Apart from the obvious financial turmoil of the times, however, there were an array of hidden reasons for the fund’s sudden fall. In public disclosures, YieldPlus’s managers had said the weighted average maturity of the bonds the fund held was six months, a mark of safety; the Securities and Exchange Commission later said the average reached as high as 2.2 years. As a result, when the broader market imploded, the fund was forced to unload its holdings at fire-sale prices, leading to deeper losses. YieldPlus’s registration statement said the managers would not place more than 25 percent of assets in certain types of securities, at least not without explicit shareholder approval. But not long before the market went into free fall, managers stuffed about 50 percent of its portfolio with nongovernment mortgage bonds, the SEC said in a January 2011 cease-and-desist order. And during the crisis, when investors and brokers asked if redemptions were draining the fund, Schwab’s lead portfolio manager said in a conference call, “We’ve got very, very, very slight negative flows,” according to the SEC. In fact, the fund had hemorrhaged more than $1 billion in the preceding two weeks. Continue Reading…