As debates heat up on the first rate hike, the Securities and Exchange Commission proposed a rule recently that mutual fund companies must disclose how vulnerable their bond portfolios are to rate hikes. The primary forms of bond risk include default risk and the interest rate risk. The latter is obviously the most important these days. Remember, a low interest rate environment is favorable for investments in bond funds. This stems from the fact that market value of a bond is inversely proportional to the interest rates.
This is among SEC's first moves to address concerns that the first rate hike in about seven years may spark a rapid sell off in bond funds, resulting in steep losses. Also, the five-member SEC's unanimous vote in favor of the proposal was to address concern that SEC's rules have not matched up with the growth and complexities of the industry. Many mutual funds have mixed portfolio and various management styles. Many use derivatives among other contracts to hedge and boost profits.
What Mutual Fund Firms Need to Disclose?
The plan requires mutual funds to publish their exposure to derivatives, repurchase agreements, and securities lending. The reports will also contain details about position-level holdings, counterparty exposures, derivatives contracts terms and the risks associated with rate hike.
Also, mutual funds will have to submit a metric called duration for the bond funds. This metric is a measure of how the bond holdings will perform if the central bank decides to hike rates by 1 percentage point. Funds will also need to disclose separate risk measure for derivatives and profits or losses on those holdings.
SEC Chair Mary Jo White said: "Investors will have better quality and greater access to information about their fund investments and investment advisers, and the SEC will have more and better information to monitor risks in the asset management industry."
A Step Forward This Time
Late in 2014, the SEC had come up with three major initiatives with the aim to better monitor associated risks in the asset management industry and to protect investors from any further crisis. White had mentioned that more needs to be done. She said then that "A broader set of proactive initiatives is required to help ensure that our regulatory program is fully addressing the increasingly complex portfolio composition and operations of today's asset management industry."
Among the three initiatives, one was improving data and related information used to infer risks of the asset management industry and undertake proper regulatory measures. White stated that though funds and advisers disclose substantial information to the SEC, it is not adequate given the growing number of new products and strategies being introduced in the industry.
Citing examples, she stated that current rules do not mandate proper reporting by several types of derivatives (financial instrument used to manage risk).
Is The Industry Happy?
Mutual funds will be disclosing these by filing monthly reports. The disclosure that will contain so many details might put the mutual fund firms in a spot of bother. The industry argues that "high-frequency traders" will use information disclosed by them to place bets before fund managers do.
Mutual fund firms such as BlackRock (NYSE:BLK) and Fidelity have lobbied against stricter guidelines for banks and insurance companies.
However to prevent the 'front running', SEC will propose to delay the reports' releases and the public will get the information on a delayed basis. Also, the SEC may withhold some information completely from the public.
Rate Hike Risk for Bond Funds
A rise in rates is feared to lead to bond exodus; when the lack of liquidity may compel investors to sell the asset class at significant discount. There is a growing concern that a massive exit from bonds may freeze the markets as the number of sellers may not match the number of buyers.
Redemption of bonds would increase the sell off and then fund managers will have to sell the less liquid assets to match the investors' cash demands. However if a mutual fund or an ETF holds illiquid bonds, the price swings will be rapid and would create a vicious cycle as price drops will again intensify selling pressure.
Mutual Funds with Limited Bond Exposure
Amid the growing concern, investors may opt to stay away from bond funds completely. In this case, we present 3 mutual funds that either carry a Zacks Mutual Fund Rank #1 (Strong Buy) or Zacks Mutual Fund Rank #2 (Buy).
Remember, the goal of the Zacks Mutual Fund Rank is to guide investors to identify potential winners and losers. Unlike most of the fund-rating systems, the Zacks Mutual Fund Rank is not just focused on past performance, but the likely future success of the fund.
Also, these funds have negligible assets invested in bonds. These funds carry no sales load, have a expense ratio below 1. The minimum initial investment is within $5000. The total return for these funds is at least 10% for 1, 3 and 5-year periods. Also, the year-to-date gain is above 5%, proving the continued strength of these funds.
Janus Global Life Sciences Fund T (MUTF:JAGLX) seeks capital appreciation over the long run. JAGLX invests a large chunk of its net assets in companies that are related to life sciences sector. JAGLX focuses on foreign and US companies believed to be involved with advancements in the life sciences, which include the healthcare, pharmaceuticals, agriculture, cosmetic/personal care, and biotechnology industries.
Janus Global Life Sciences T currently carries a Zacks Mutual Fund Rank #1. Nearly 95% of assets are allocated to stocks, and no amount of asset is invested in bonds. The annual expense ratio of 0.92% is lower than the category average of 1.37%. JAGLX has returned 18.6% year to date while 1, 3 and 5-year returns stand at 47.8%, 40% and 31%.
The Hartford Growth Opportunities Fund I (MUTF:HGOIX) seeks short and long-term capital appreciation. HGOIX invests in a varied portfolio of a wide range of industries, companies and market capitalizations having high growth prospects. It may also trade securities actively.
Hartford Growth Opportunities I currently carries a Zacks Mutual Fund Rank #1. About 90.4% of assets are allocated to stocks, and no amount of asset is invested in bonds. The annual expense ratio of 0.91% is lower than the category average of 1.19%. HGOIX has returned 10.3% year to date while 1, 3 and 5-year returns stand at 21.8%, 23.3% and 18.7%.
T. Rowe Price Global Stock Fund (MUTF:PRGSX) invests in prominent companies across the globe. PRGSX largely invests in diversified industries from the developed nations and also invests a small portion in emerging economies. It invests in a minimum of five countries including the U.S. A minimum of 40% of its assets are invested in foreign companies.
T. Rowe Price Global Stock currently carries a Zacks Mutual Fund Rank #1. Over 97% of assets are allocated to stocks, and only 0.22% of asset is invested in bonds. The annual expense ratio of 0.89% is lower than the category average of 1.31%. PRGSX has returned 7.7% year to date while 1, 3 and 5-year returns stand at 10.2%, 19.3% and 13.6%.
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