Sunday, July 31, 2011

Shareholders in Muni Bond Fund Bailing out the Issuers of Muni Bonds...Could Lawsuits Be Far Behind?

Soon after I started reading the following article in yesterday's Weekend Wall Street Journal, I did a "double- take" to check the date to make sure it wasn't April 1st and to confirm this wasn't some kind of sick April's Fools day joke. Unfortunately it is no joke.
Here is an excerpt from the article:
"This week, shareholders in 32 closed-end municipal-bond funds sponsored by Nuveen Investments voted on a proposed change that would permit the funds to make loans to issuers of muni bonds 'in circumstances where a municipal issuer is in distress.' Nuveen is one of the largest managers of tax-free bond funds, with some $76 billion in such assets..the plan sheds light on a little-known occurrence: the use of a fund's assets to provide life support to borrowers that can barely make interest payments on bonds already owned by the fund. Such loans are rare but could become more common, say fund experts."

So let me see here. I invest in a technology ETF with a major institution like Fidelty.   Then let's say, heaven forbid, the tech sector crashes on reports of earnings that have fallen off a cliff, so Fidelty decides to loan some money to some of the largest firms that comprise this ETF to help get them through the rough patch. A bad idea? No, a really, really %$^&# bad idea. Setting aside the potential legal risk which I think is potentially huge (even if the fundholders voted to "approve", when things go sideways, which I would forecast a high probability that they will, the clarity of the disclosure and consents, among other items, will be questioned), it is just bad business. One of the key reasons for someone to invest in a fund is to achieve some level of diversification. You probably won't make a killing but you also won't lose 90% (or more) of your investment. I would hope that even if a few municipalities are shaky, the majority in any given fund would be sufficiently safe. What on earth are the folks at Nuveen thinking? Or is the situation really that dire in the muni bond market?


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