Conditions this summer are worsening for investors in Puerto Rico's shaky, high-risk municipal bonds.
As this blog recently noted, UBS clients who invested in Puerto Rico bonds face extreme risks. The Swiss bank acknowledged as much two weeks ago when it reported it was handling $600 million in damage claims filed by securities fraud attorneys on behalf of Puerto Rico closed-end bond fund investors.
But it is not only UBS clients who bought individual Puerto Rico bonds or closed-end funds who are staring at darkness and confusion down the road. Investors who purchased supposedly safe and sound municipal bond mutual funds from industry giants such as OppenheimerFunds and Franklin Templeton also have plenty of reasons to worry.
"OppenheimerFunds Inc., the largest holder of Puerto Rico debt among mutual funds, has seen some of its funds lose almost a third of their assets in the past year," according to Bloomberg reporter Michelle Kaske.
"Investors are pulling cash from the New York-based company's funds as bondholders speculate Puerto Rico will be unable to repay all of its $73 billion of commonwealth and agency debt," Kaske reported last week. "Prices on Puerto Rico bonds set record lows in July after legislators passed a law that would enable certain public corporations, including the Electric Power Authority, to ask investors to take a loss."
Among OppenheimerFunds funds that hold Puerto Rico bonds, two have contracted by almost 33 percent in the past year, according to Bloomberg data, Kaske reported. Two others have shrunk by about 29 percent.
OppenheimerFunds is not the only mutual fund company that bet heavily on Puerto Rico bonds and is now casting a long dark shadow over its clients. Franklin Templeton's Franklin Double Tax-Free Income Fund is another spectacular failure, according to an analysis by Conrad de Aenlle of MarketWatch.
The funds "performed well against its peers from the end of 2008 until May 2013, then embarked on an 18.7% drop for the rest of the year, a period when the average muni-bond fund fell 4.7%," de Aenlle wrote, citing data from investment research shop Morningstar. "That has left the $286 million fund's returns through July in the bottom 1% over one- and three years, and the bottom 3% over five- and 10 years."
The reason for Franklin Double Tax-Free Income's appalling performance is simple: its huge bet on Puerto Rico bonds.
As de Aenlle noted: "It's no coincidence that Franklin Double Tax-Free Income started to drop out of sight around the time that alarm spread about deteriorating financial and fiscal conditions in Puerto Rico. Almost two-thirds - 63.4% - of the portfolio was allocated to Puerto Rico bonds as of June 30, the most recent reporting date. That's more by far than any other muni fund in Morningstar's database."
Owning Puerto Rico bonds was supposed to be an advantage to investors looking for the perk of extra tax free income. Stock brokers and investment advisers sold their clients these funds because of that tax free benefit, which has now turned into a massive liability.
The bond market is at the end of a historic, 30-year bull market. Economic and market experts widely anticipate over the next couple of years an increase in interest rates, which have been at record lows in the aftermath of the great recession. As interest rates rise, the value of bonds goes in reverse and falls. That means that these OppenheimerFund and Franklin Templeton municipal bond fund investors who have watched the value of their holdings plummet due to their exposure to Puerto Rico will be hammered yet again in a rising interest rate environment.
It is dark now for all Puerto Rico bond investors, and it will likely get worse.
Zamansky LLC are securities and investment fraud attorneys representing investors in federal and state litigation against financial institutions. For more information about Zamansky LLC, please visit here.
Important Disclosure: Zamansky LLC represents investors in arbitration cases against UBS regarding Puerto Rico bonds and UBS closed end bond funds, Lehman structured products and other investments.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.