Subprime losses squeeze Fidelity fund
By Elizabeth Stanton
Bloomberg News
Friday, August 3, 2007
NEW YORK: The Fidelity Investments Inflation-Protected Bond Fund is lagging behind its counterpart at Vanguard Group after taking losses in subprime mortgages, the worst-performing debt market this year.
The $1.3 billion mutual fund, run by William Irving in Merrimack, New Hampshire, rose 3.3 percent this year, trailing the 4 percent gain of the Vanguard Inflation-Protected Securities Fund, which holds no mortgage bonds. The Fidelity fund advanced at an annual rate of 5.6 percent during the past five years, compared with the 6 percent return of the $10.2 billion Vanguard fund, data compiled by Bloomberg show.
The Fidelity fund has disappointed investors as defaults on home loans to people with limited credit rose to the highest level in a decade. The ABX-HE-BBB-06-1 index, tied to mortgage-backed bonds with the lowest investment-grade ratings, fell more than 60 percent this year, according to Markit Group of London.
"Someone who's investing in lower-quality securities to help performance, even to a limited extent like the Fidelity fund, is taking a chance," said Paul Herbert, an analyst at Morningstar, the Chicago research firm.
The fund, which attempts to provide returns that exceed the rate of inflation by purchasing Treasury inflation-protected securities, or TIPS, had 0.5 percent of its assets in derivatives linked to subprime loans, according to Morningstar.
It also was hurt because 18 percent of its assets were in the Fidelity Ultra-Short Central Fund, another subprime holder.
Irving's fund lost Morningstar's four-star rating on July 3 and now has three stars out of a possible five. Its Sharpe ratio of minus 0.08 compares with the three-year average of minus 0.16 for its peers. A higher ratio indicates higher risk-adjusted returns.
The Vanguard Inflation-Protected Securities Fund holds only TIPS or other Treasury securities, said its co-manager, Kenneth Volpert. It returned 4.49 percent in the past 12 months, more than the 3.63 percent average of funds that invest in TIPS, according to data compiled by Morningstar.
"Our investors value the simplicity and purity of the fund," Volpert said. Vanguard, based in Valley Forge, Pennsylvania, is the second-largest mutual-fund company after Fidelity.
The Fidelity fund rose 3.87 percent in the past year, Morningstar data show. It gained at an annual rate of 3.75 percent over the past three years, beating the 3.39 percent average of its rivals.
Late payments for subprime home loans climbed to almost 13.8 percent in the first quarter, five times the rate of so-called prime loans to creditworthy borrowers, according to a June 14 study from the Mortgage Bankers Association in Washington.
Irving, who has run the Fidelity fund for the past three years, used credit-default swaps to wager that the price of insuring $6.7 million of subprime mortgage-backed bonds against default would decline, according to the fund's annual report dated April 30.
"The fund had a very modest amount of its assets invested in subprime mortgage securities," said Sophie Launay, a spokeswoman at Fidelity in Boston. Irving declined to comment.
In a credit-default swap, an investor buys or sells insurance on a bond. As a seller, the Fidelity fund got a fixed payment in return for making later payments if the bonds default. If the perceived risk of default rises, the seller's contract loses value.
The 14 credit-default swaps in the Fidelity Inflation-Protected Bond Fund reduced returns, according to the annual report.
TIPS pay interest at a lower rate than Treasury notes and their face amount is linked to the Labor Department's consumer price index. The 10-year TIPS issued in January that pays interest at 2 3/8 percent made its first semiannual payment July 15 on a principal amount of $1,027.73. The 10-year Treasury note sold in February pays interest at a 4.625 percent rate on a $1,000 principal amount.
Some inflation-protected bond funds invest in other securities because the TIPS market consists of 24 bonds with a combined value of $437 billion, limiting a manager's choices, said Herbert of Morningstar. Managers also seek higher returns with lower-rated securities.
Of the six funds monitored by Morningstar, only Fidelity's ventured into subprime mortgages, he said. |
