Investors in the beleaguered UBS Puerto Rico family of closed-end municipal bond funds are losing billions.
Nineteen closed-end local muni bond funds sold by UBS Financial Services Inc. of Puerto Rico brokers lost $1.66 billion during the first nine months of last year, with the biggest losers being UBS Puerto Rico funds that had large holdings of muni bonds that were originally brought to market with UBS as the underwriter, according to new research by a consulting group.
The market for Puerto Rico's $70 billion muni debt bottomed out after Detroit filed for bankruptcy in July.
UBS Financial Services Inc. of Puerto Rico is a significant player in the muni-debt market in Puerto Rico, having packaged and sold $10 billion in proprietary closed-end bond funds from 2002 through the end of 2012, according to company marketing material.
“These funds were sold almost exclusively to citizens of Puerto Rico, and approximately 70% of the portfolios of these funds were invested in Puerto Rican securities,” according to a blog post written by Edward S. O'Neal, a principal with the Securities Litigation & Consulting Group, which works with plaintiff's attorneys and state regulators. “The percentage losses over the past year range from 38% to 48% for the worst performing UBS PR funds.”
The Standard & Poor's Municipal Bond Puerto Rican Index was down 17% during the first nine months of last year, Mr. O'Neal added in the blog, which was posted last Monday.
"Although the PR closed-end funds have suffered losses in the latter part of 2013, as a result of the well-known decline in the Puerto Rico municipal bond market, the funds have historically provided strong tax-advantaged returns to clients for many years,” UBS spokesman Gregg Rosenberg wrote in an e-mail to InvestmentNews.
Overconcentration in the securities of two Puerto Rico muni issuers, the Employees Retirement System of the Government of the Commonwealth of Puerto Rico and its Instrumentalities and the Puerto Rico Sales Tax Financial Corp., was the undoing of many of the funds, Mr. O'Neal said in an interview Monday.
“It appears or looks like UBS lobbied and asked for a waiver to hold more concentrated positions” in the closed-end bond funds than usually allowed under the Puerto Rico Investment Companies Act, he said.
Funds that are “diversified” can invest no more than 5% of the portfolio in a single issuer under Puerto Rico regulations, and non-diversified funds are limited to hold no more than 25% in a single issuer, Mr. O'Neal said.
The UBS Puerto Rico closed-end funds that lost the most were “concentrated in issues they underwrote,” he said.
“We show that the losses emanated from concentration in fixed-income issues that were originally brought to market by UBS as an underwriter,” Mr. O'Neal said.
For example, the PR Fixed Income Fund V saw a decline of 48% in its total return during the first nine months of last year.
That fund's assets were 31.6% in Employees Retirement System debt and 19.9% in Sales Tax Financing's debt, according to SLCG's research.
“Why was UBS buying this debt? We're not sure, but UBS was the underwriter on all those issues,” Mr. O'Neal said.
“We have not talked to the fund managers,” he said. “We don't know their rationale for holding those positions.”
The less-concentrated portfolios outperformed the more concentrated, Mr. O'Neal said.
The four UBS Puerto Rico closed-end funds that held just 5.2% of their portfolios in these two issuers had losses of 16.3% on average, in line with the broad Puerto Rico muni-bond market, he said.
“The assertion by SLCG that the funds obtained waivers in order to hold more concentrated positions is flatly wrong,” Mr. Rosenberg wrote. “The funds are required to hold at least 67% of their assets in Puerto Rico assets, including Puerto Rico municipal bonds, in order to maintain their tax-advantaged status for retail investors. The temporary relief obtained by the funds, and inaccurately cited by SLCG, waives the 67% requirement, thereby permitting the funds to reduce their concentrations in Puerto Rico bonds.”
The waiver to an investment company owning more than 25% from one issuer and cited in the SLCG blog post was from the 2003 prospectus for the Puerto Rico Fixed Income Fund I.
Those regulations have since changed. A law passed in 2013 essentially did away with investment companies needing to request such a waiver, providing that the investment company invested in Puerto Rico or U.S. securities.