Schwab’s largest bond fund still tumbling

The Charles Schwab Corp.’s largest bond fund has lost more than 80% of its assets over the past 10 months as investors have fled the mortgage-backed securities in which it invested heavily.

Assets in the HighYield Plus Select Fund (SWYSX) had declined to $2.5 billion as of March 20, down from $4.5 billion as of Feb. 29, and from $13 billion in May. The fund invests in bonds with a maturity of less than two years.

As of Feb. 29, more than half its assets were in mortgage-backed securities.

“That fund is in so much trouble,” said Matthew Wright, an adviser at Wade Financial Group Inc. of Minneapolis, which manages $160 million. “Anyone left in there needs to get out.”

The redemptions are forcing portfolio managers at the San Francisco-based brokerage giant to sell assets at a loss to raise cash for investors looking to bail out, according to financial advisers and press reports.

“[The fund’s managers] are being forced to sell asset-backed and mortgage-backed securities, and nobody is buying that stuff in the market” because of fears created by the subprime crisis,” Mr. Wright said.

HighYield Plus has $1.31 a share of realized losses and $0.61 of unrealized losses, according to Morningstar Inc. of Chicago.

NAV DROPS

The net asset value per share of HighYield Plus had sunk more than 18% year-to-date as of last Wednesday, to $7.45 from $9.09.

The losses are the basis of a class action that Hagens Berman Sobol Shapiro LLP of Seattle filed March 18 in the U.S. District Court for the Northern District of California in San Francisco.

The lawsuit, filed on behalf of investors who bought different share classes of the fund between March 2005 and the middle of this month, claims that Schwab made “positive but misleading or untrue statements” in advertisements and other Schwab communications.

For instance, the lawsuit quoted Schwab literature as saying, “The [HighYield] funds provided higher yields on your cash with only marginally higher risk [and therefore] could be a smart alternative.”

Also, the fund is an “ultra-short-term bond fund designed to offer high current income with minimal changes in share price.”

In response, David Weiskopf, a spokesman for Schwab, said the company “believes the allegations of the lawsuit are without merit and that the fund prospectus met legal requirements. We plan to defend against the lawsuit.”

[More: Schwab turns down slice of bailout pie]

In addition to the alleged misleading comments, the explanations of risk were insufficient, said Reed Kathrein, a Berkeley, Calif.-based partner in Hagens Berman.

“They have all kinds of risk disclosures, but not disclosures of what they’re actually doing. What we have here are omissions about what they were really investing in,” Mr. Kathrein said.

“It does not say subprime, or that they have a concentration of mortgage-related investments,” he said.

But Schwab might have stayed within normal bounds for an ultra-short-term bond fund.

“This fund took on more risk than peers, but I don’t think it would normally turn a lot of heads to see these kinds of holdings,” said Miriam Sjoblom, mutual fund analyst for Morningstar.

RANKED LAST

Morningstar ranks HighYield Plus last among ultra-short-term bond funds.

Competitive funds on average have lost only 1.3%, Ms. Sjoblom said.

When issues surrounding HighYield Plus arose last fall, Schwab held several teleconferences to discuss it with advisers (InvestmentNews, Dec. 17).

During those calls, Schwab sought to reassure the advisers, but since then, the situation has radically worsened, Mr. Wright said.

“I added [cash] to [HighYield Plus] in early December,” he said.

“Thank God I got out [in February] before the real damage was done,” Mr. Wright said. “Anyone who is still in there is in serious trouble.”

Although Schwab continues to hold occasional conference calls with advisers about HighYield Plus, some still don’t understand the situation the fund is in, Mr. Wright said

On the last call early this month, one adviser asked if HighYield Plus was a good place to put his clients’ short-term cash, Mr. Wright said.

E-mail Brooke Southall at [email protected].