Attorney Daily - Your source for the most important legal news

The Charles Schwab YieldPlus Fund plunged 9.9% during March 2008, the most among peers sold as alternatives to low-risk money-market accounts, as subprime-bond losses infected home loans to borrowers with better credit.

The $4.9 billion fund, managed by a five-member team at Charles Schwab Corp., seeks to generate “high current income with minimal changes in share price,” according to the San Francisco-based company’s Web site. Assets have dropped from approximately $10.6 billion in August 2007, spokeswoman Sondra Harris said.

The fund has lost 11% this year, ranking last out of 50 “ultra-short” bond funds tracked by Morningstar Inc., the Chicago-based research firm. SSGA Yield Plus, managed by Boston- based State Street Corp., is next with a 10% decline. The category has fallen an average of 1.12%.

“It’s a combination of unprecedented market conditions and also a bolder investment approach,” Miriam Sjoblom, a fund analyst with Morningstar, said in an interview. “The odds of turning around don’t look that good.”

About 38% of the YieldPlus fund was invested in non- subprime mortgage securities without guarantees from governmentchartered Fannie Mae or Freddie Mac and about 9% in asset-backed securities including subprime-loan bonds as of Dec. 31, according to the latest disclosures on Schwab’s Web site. An estimated 34% of the fund was in corporate bonds.

Safety, Liquidity

The fund’s stumble reflects the accelerating pace at which a debt-market collapse that began with subprime mortgages, those made to borrowers with poor credit histories, has spread to other securities, including home loans considered less likely to default. Investors are hoarding super-safe Treasuries and refusing to buy most other varieties of debt.

The yield on the two-year Treasury note has fallen to 1.53%  from 3.05% at the start of the year.

Ultra-short bond funds were marketed to investors as a higher-yielding alternative to money-market funds, which offer a combination of safety and liquidity, or the ability to quickly access cash. The substitutes buy short-term debt, including subprime, and have fewer investment restrictions than money funds.

Money funds are considered the safest investments besides bank accounts and government debt. They’re required to hold debt that matures in 13 months or fewer and maintain top short-term corporate debt ratings. The average seven-day yield on money- market funds was 3.12% on March 17, 2008, according to the Crane 100 Money Fund Index.

Two Stars

“The fixed-income markets continue to suffer from a lack of buyers for many types of securities,” Kim Daifotis, chief investment officer of fixed income at Schwab’s fund unit, and Randall Merk, executive vice president, wrote in a shareholder letter dated March 10 and posted on the Web site.

“Unfortunately, this situation shows no immediate signs of improvement and is continuing to affect the net asset value,” of the fund. Daifotis leads the team that runs the fund.

Morningstar gives the fund two stars of a possible five. YieldPlus has a three-year Sharpe ratio of 1.2, compared with 0.97 for competing funds, Morningstar’s data show. A higher Sharpe ratio means better risk-adjusted returns.

Merk and Daifotis said in the letter that the fund would attempt to maintain “a high level of cash in the portfolio to honor redemptions with as little disruption as possible to the fund.”

Holding More Cash

Cash as a percentage of holdings has increased to 15%, according to Harris, the Schwab spokeswoman. The fund had 2.3% cash on Nov. 30. Daifotis and Merk weren’t available for comment, Harris said.

As of Oct. 30, the Schwab Retirement Income Fund held 1.6 million shares in the YieldPlus fund. Four other Schwab retirement-date funds are also listed as shareholders.

YieldPlus seeks to keep the average duration of its portfolio at one year or less. The fund lost 1 percent in 2007, compared with an average 4.1% gain by rival funds, according to Bloomberg data.

“It was never, ever considered a risky fund and we continue to manage the fund in the best interest of our shareholders,” Harris said

The Charles Schwab YieldPlus Fund a popular offering in recent years that sought to offer investors attractive yields with minimal changes in share price has become the target of litigation over a bond fund that has declined substantially amid the subprime-mortgage meltdown.

The fund wasn’t a money-market fund, but instead a short-term bond fund. It primarily invested in investment-grade bonds, focusing on areas like corporate bonds, commercial and residential mortgage-backed securities and collateralized mortgage obligations.

The fund topped $10 billion in assets last year, but has declined to $2.5 billion amid losses. Big stakes in mortgage-backed securities, which comprised about half of the fund’s net assets through the end of February 2008, have soured amid weakened demand in the sector.

In recent days, attorneys filed a complaint against Schwab seeking class-action status in U.S. District Court in the Northern District of California. The suit is for investors who bought different share classes of the fund from March 2005 to mid-March 2008.

It alleges that Schwab’s investment advisers, officers and directors issued untrue statements about the fund’s diversification and risk, misleading investors about how the offering provided “higher yields on your cash with only marginally higher risk,” according to the complaint.

Schwab YieldPlus Fund is down 18.5% in the past year, and 15% in the past month alone, putting it at the bottom of its ultra-short bond-fund category. On average, such funds are down 0.37% in the past year.

A Schwab spokeswoman said that “the allegations of the lawsuit are without merit,” and that “the fund prospectus met legal requirements.”

San Francisco-based Schwab said this month that “forced selling of bonds by institutional leveraged investors” and “market pessimism” have been two of the latest issues contributing to problems. The fund’s net asset value has continued to decline, and the fund is holding a cash position of more than 11% to provide a cushion as it continues to face pressure.