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Bond IOs can work like magic, but then can blow up suddenly and unexpectedly. See the recent blowup of IOXIX (it WAS a strong performer in 2022 until...). Twitter LINK
Seems like MBXIX is the only fund from Catalyst that has delivered on its promises long term. IOXIX is an excellent illustration of why some investment strategies belong only in interval or closed-end fund structures. Outflows forced the manager to sell illiquid assets at fire sale prices.
The Fund seeks to deliver monthly dividend income derived from its investments in mortgage-backed securities (“MBS”), including U.S. agency and non-agency residential MBS, commercial mortgage-backed securities (“CMBS”), asset-backed securities (“ABS”) (including privately-offered collateralized loans), and real estate investment trusts (“REITs”). The Fund also invests in structured notes and total return swaps linked to foreign and domestic bonds, foreign and domestic money market funds, foreign and domestic interest rates, changes in interest rates, foreign and domestic bond futures, foreign and domestic credit default swaps and changes in exchange rates. U.S. agency MBS in which the Fund may invest include pass through and structured securities, such as fixed, floating and inverse floating rate collateralized mortgage obligations (“CMOs”) as well as interest-only and principal-only MBS
After:
The Fund seeks to deliver monthly dividend income derived from its investments in agency mortgage-backed securities (“MBS”). The Fund will likely invest in securities that may have negative duration, meaning the value of some of its investments may go up when interest rates rise. Additionally, the Fund will seek to be tactical in its approach to investing so that it is not overly exposed to interest rate in one direction or another by buying a variety of agency MBS interest only securities, agency MBS inverse interest only securities, and agency collateralized mortgage obligations (“CMOs”).
It looks like, with interest rates rising rapidly, the fund decided to go all in on agency MBSs and derivatives. Those tend work until they don't, i.e. when they are stressed too far. Complete management change as well, concurrent with the strategy overhaul.
Doesn't matter now. The fund is kaput (cue dead parrot sketch). "The Board has determined to close the Fund and redeem all outstanding shares on November 3, 2022 (“Liquidation Date”)."
@sma3 : " I haven't trusted these guys for several years since they retroactively changed the price of a fund I sold a week or two later, in their favor "
I didn't know a MF could do this. Would it be possible to explain more on this rip-off ?
@Derf Let's say you own an exotic security as the manager of a fund that no one else owns. How do you value this security as it doesn't trade on any exchanges? You hire an outside pricing service to value it based on comparing it to similar but not identical exotic securities that trade more frequently. During a significant market downturn no one is trading your weird security and the pricing agency says the issuer of it isn't financially impaired, so it continues to value it at the price you paid for it. But the shareholders of your fund are getting nervous because the market is tanking. Your fund is structured as a traditional mutual fund that provides daily redemptions to shareholders, even though your weird security has zero daily liquidity--a complete mismatch. Once your shareholders get nervous enough they start selling your fund and to meet redemptions you have no choice but to sell your weird exotic security no one else owns and no one really wants to buy in a severe downturn. Suddenly you have to turn to a buyer of last resort in a liquidity crisis, perhaps a hedge fund.
In fact the hedge fund guy has been watching your fund for a while, recognizes that you are another idiot mutual fund manager who doesn't recognize how serious liquidity risks are for daily redemption mutual funds or, worse, you are a manager who recognizes the risks but simply doesn't care because all that matters to you are collecting fees and the exotic security provided nice returns for a while and helped you gather assets. Now in the liquidity crisis, the hedge fund manager offers a bid for your stupid exotic investment at half its face value. He is the only bidder that high and there are others offering much less because they know you're desperate. You need to liquidate this stupid investment to pay the redeeming shareholders their cash. The hedge fund buyers are sharks smelling blood in the water. So, you sell it for half the price your pricing vendor valued it at for months. And suddenly, you mark your entire fund's NAV down 20% or 30% in one day.
The problem is many bonds and debt securities don't trade every day and liquidity crunches just kill the mutual funds invested in them. This hypothetical illustration is not so unusual as it seems. The worst part is--the exotic security might not be a bad investment in a normal market environment and could still pay off at full face value when things settle down. In fact, this is why the hedge fund manager wants to buy it in the first place. The thing he bought at half price may once again be valued at full value. That's why such exotic securities belong in closed-end funds, hedge funds, pension plans and interval funds--vehicles that aren't subject to liquidity runs on the bank.
@yogibearbull Your analysis is correct for the dangers of these exotic securities, yet the suddeness of the decline sounds like a liquidity crunch and a repricing based on that. Here what Balchunas said:
Here's one of the most fascinating, and unnatural, charts of the year IMO of an active bond fund (IOXIX) that was basically flat up till Aug, seemingly sidestepping bondmageddon, then bam- it drops 34% as outflows force NAV to get real.
Basically, managers are providing what is known as "stale prices" for their illiquid securities until redemptions force them to accept much lower bids.
@LewisBraham - @yogibearbull : Thanks for you're replies. After rereading sma3 I understand what he was trying to tell me. For some reason I thought he sold some or all of that fund & then they came back later to claim some of the sale price as NAV had fallen. My Bad, Derf
The difficulty is in accurately price securities. Securities don't have to be exotic to be illiquid and thus difficult to price. As Lewis later wrote, "The problem is many bonds and debt securities don't trade every day."
Not that long ago (early 2021) we saw a similar problem with IQDAX. As @hank quoted from the WSJ then:
“(The) firm unexpectedly halted redemptions in February and said it couldn’t value its holdings. The move stunned market participants, some of whom viewed their investments in the fund as a hedge to their broader portfolios. Infinity held wide-ranging bets across stock, currency and derivatives markets, including over-the-counter positions … Infinity appeared to have misvalued its large derivatives portfolio. Some of the valuations it disclosed were too high and, in one instance, mathematically impossible.”
The fund had manipulated a third party pricing algorithm. Presumably that was to make the fund look better; I don't imagine the tweaking was done to make it look worse.
I wonder how much of this sort of mispricing is due to ineptness, and how much is deliberate.
My contribution to that thread was to refer back to Heartland, which grossly (44% and 70%) mispriced HY muni bonds two decades ago. Munis, even junk, are not derivatives, and not something I'd consider esoteric (are Puerto Rican bonds "esoteric"?). Not esoteric, but still some are thinly traded and difficult to price.
Regarding munis, see also WSJ, Mutual Funds' Muni-Debt Prices Are Questioned, Feb 18, 2011. No great surprise that it mentions the highly volatile Oppenheimer Rochester funds (now owned by Invesco). "Scrutiny of junk muni-bond values by the SEC includes "tobacco bonds". That article also talks about deliberate mispricing.
Twice I have had a mutual fund company several months later change the price at which I sold their fund, to their advantage I might add.
In 2016 I sold MBXIX in two of our accounts at one price, only to have Schwab and Fidelity later change the price, resulting in less money to us.
Most recently I sold FARIX in both my and my wife's retirement accounts for $9.20 a share on July 15 2022, only to have both Schwab and Fidelity change the price to $9.14 on September 22,2022. They canceled the first trade and put in another at the lower price, resulting in $300 fewer dollars to us.
Schwab was nice enough to send a letter. Fidelity never notified us. I called Schwab and they said that if a mutual fund company tells them a previous price was inaccurate, they accept that number and follow thru, changing the trade.
I posted about the MBXIX when it happened, and have never wanted to do business with Catalyst again. I emailed them but never got a reply. I think I even emailed the SEC.
I assume the change was for the reasons stated above, ie thinly traded securities, but it is amazing that the SEC lets companies do this, rather than making them eat the difference.
Given these examples, and the IOXIX example and IOFIX disaster a year or so ago, I am very leery of investing large sums in funds using "thinly traded" securities.
Of course, with the very broad mandates most funds have now, you hardly know what many mangers are buying.
If anybody else has had this problem, I would like to hear about it. Maybe if enough people complain something will be done
@sma3 : Thanks for that reply. It would be of interest, to see how much leeway the SEC will give MF's before the hammer is applied. I'm going to tag a few contributors & see if they can add any info.
Having a security valued at $10 by an outside pricing service even though the manager senses that price is stale and the security could only fetch $8 if he had to sell it in a falling market I would suspect creates plausible deniability from a legal perspective. There is also a legitimate question as to what the security is "worth" from a sense of intrinsic value versus what you could get for it price-wise during panic selling and a liquidity crunch. Let's say you have such panic selling of all stocks and bonds, but you own the bond of an issuer that still has a viable business and can pay the debt's interest and principal on time. You might be only able to get 80 cents on the dollar of the face value of the bond if redemptions force you to sell the bond during a panic. Yet the bond in a normal environment could be judged worth full face value. So, you can claim in a court that even though you ended up selling it at a 20% discount due to redemptions, you and the pricing service were correct in pricing it at its full par value right before you sold it. Still, I suspect mfs might have a better answer for this than me.
I suspect the most viable cases for pursuing legal action involve actual credit impairment of the issuer which the manager or the pricing service declines to acknowledge in the valuation of the security. If the manager knows an issuer is heading towards default yet continues to value the security at par, that's a big no-no. That's why I believe the Heartland muni bond fund case was a slam dunk for the SEC. From MFS's linked article:
In 2008, Heartland Advisors agreed to pay $3.5 million to settle an SEC lawsuit over the drastic markdown of two municipal bond funds in 2000. The SEC said the investment firm was negligent in failing to properly price the value of some bonds in the Short Duration High-Yield Municipal Fund and the High-Yield Municipal Fund. The funds had invested mainly in nonrated medium- and lower-quality municipal bonds. When the projects underlying some bonds held by the funds went into default and other projects were failing, Heartland didn't make sure the funds were priced accurately, the SEC asserted.
I understand that on July 15th the rarely sold securities in FARIX were "estimated" to be worth X by their valuation firm. This allowed them to price the fund at $9.20.
OK, But then what happened between then and September 22?
IF they sold lots of this "estimated" junk, when they sold it what it was worth, as it was marked to a market price..
( Why did it take till September 22 for them to "find" another price that they retroactively applied to the NAV on July 15?)
If it was not sold on July 15th, but many months later, how can you apply a "mark to market price" in September to a NAV in July?
I think a better explanation is there were lots of redemptions, and they paid them out, but when they finally unloaded some of this stuff, they didn't make the cash they wanted, so they went back and "Adjusted" the prices to allow them to be whole, not their investors.
As of June 30, 2022, we noted that controls over the Fund’s valuation of forward exchange contracts were not operating effectively and as a result the fair value of one contract was incorrect resulting in a material misstatement of the Fund’s net assets. Management of the Fund has reviewed the processes and controls that gave rise to the deficiency, and as a result, has implemented changes that management believes will allow for the prevention and/or timely detection of similar deficiencies on a prospective basis. These conditions were considered in determining the nature, timing, and extent of the procedures performed in our audit of the financial statements of the Fund as of and for the year ended June 30, 2022, and this report does not affect our report thereon dated September 1, 2022.
I do think this is a different situation from the one I'm describing from the sound of it, although the period the misstatement occurred was a volatile one.
It does seem similar to when a company restates its past earnings due to an accounting error. Whether or not the fund company should've eaten the costs of their mistake instead of making you and other shareholders pay for it is an interesting question.
Comments
Before: After: http://catalystmf.com/docs/funds/income_oriented_strategies/Catalyst_Enhanced_Income_Strategy_Fund/prospectus.pdf
It looks like, with interest rates rising rapidly, the fund decided to go all in on agency MBSs and derivatives. Those tend work until they don't, i.e. when they are stressed too far. Complete management change as well, concurrent with the strategy overhaul.
Doesn't matter now. The fund is kaput (cue dead parrot sketch).
"The Board has determined to close the Fund and redeem all outstanding shares on November 3, 2022 (“Liquidation Date”)."
I didn't know a MF could do this. Would it be possible to explain more on this rip-off ?
In fact the hedge fund guy has been watching your fund for a while, recognizes that you are another idiot mutual fund manager who doesn't recognize how serious liquidity risks are for daily redemption mutual funds or, worse, you are a manager who recognizes the risks but simply doesn't care because all that matters to you are collecting fees and the exotic security provided nice returns for a while and helped you gather assets. Now in the liquidity crisis, the hedge fund manager offers a bid for your stupid exotic investment at half its face value. He is the only bidder that high and there are others offering much less because they know you're desperate. You need to liquidate this stupid investment to pay the redeeming shareholders their cash. The hedge fund buyers are sharks smelling blood in the water. So, you sell it for half the price your pricing vendor valued it at for months. And suddenly, you mark your entire fund's NAV down 20% or 30% in one day.
The problem is many bonds and debt securities don't trade every day and liquidity crunches just kill the mutual funds invested in them. This hypothetical illustration is not so unusual as it seems. The worst part is--the exotic security might not be a bad investment in a normal market environment and could still pay off at full face value when things settle down. In fact, this is why the hedge fund manager wants to buy it in the first place. The thing he bought at half price may once again be valued at full value. That's why such exotic securities belong in closed-end funds, hedge funds, pension plans and interval funds--vehicles that aren't subject to liquidity runs on the bank.
https://ybbpersonalfinance.proboards.com/thread/90/bond-factory-structured-credits
My Bad, Derf
Not that long ago (early 2021) we saw a similar problem with IQDAX. As @hank quoted from the WSJ then: https://mutualfundobserver.com/discuss/discussion/comment/146295/#Comment_146295
The fund had manipulated a third party pricing algorithm. Presumably that was to make the fund look better; I don't imagine the tweaking was done to make it look worse.
I wonder how much of this sort of mispricing is due to ineptness, and how much is deliberate.
My contribution to that thread was to refer back to Heartland, which grossly (44% and 70%) mispriced HY muni bonds two decades ago. Munis, even junk, are not derivatives, and not something I'd consider esoteric (are Puerto Rican bonds "esoteric"?). Not esoteric, but still some are thinly traded and difficult to price.
Regarding munis, see also WSJ, Mutual Funds' Muni-Debt Prices Are Questioned, Feb 18, 2011. No great surprise that it mentions the highly volatile Oppenheimer Rochester funds (now owned by Invesco). "Scrutiny of junk muni-bond values by the SEC includes "tobacco bonds". That article also talks about deliberate mispricing.
The specific funds change, the practices remain.
You read what I meant correctly the first time.
Twice I have had a mutual fund company several months later change the price at which I sold their fund, to their advantage I might add.
In 2016 I sold MBXIX in two of our accounts at one price, only to have Schwab and Fidelity later change the price, resulting in less money to us.
Most recently I sold FARIX in both my and my wife's retirement accounts for $9.20 a share on July 15 2022, only to have both Schwab and Fidelity change the price to $9.14 on September 22,2022. They canceled the first trade and put in another at the lower price, resulting in $300 fewer dollars to us.
Schwab was nice enough to send a letter. Fidelity never notified us. I called Schwab and they said that if a mutual fund company tells them a previous price was inaccurate, they accept that number and follow thru, changing the trade.
I posted about the MBXIX when it happened, and have never wanted to do business with Catalyst again. I emailed them but never got a reply. I think I even emailed the SEC.
I assume the change was for the reasons stated above, ie thinly traded securities, but it is amazing that the SEC lets companies do this, rather than making them eat the difference.
Given these examples, and the IOXIX example and IOFIX disaster a year or so ago, I am very leery of investing large sums in funds using "thinly traded" securities.
Of course, with the very broad mandates most funds have now, you hardly know what many mangers are buying.
If anybody else has had this problem, I would like to hear about it. Maybe if enough people complain something will be done
@msf - @hank - @LewisBraham _ @Junkster : Fellow investors would you be able to add to this thread ?
Thanks, Derf
Doubt it will do any good
I suspect the most viable cases for pursuing legal action involve actual credit impairment of the issuer which the manager or the pricing service declines to acknowledge in the valuation of the security. If the manager knows an issuer is heading towards default yet continues to value the security at par, that's a big no-no. That's why I believe the Heartland muni bond fund case was a slam dunk for the SEC. From MFS's linked article:
What I find inexplicable is the timing.
I understand that on July 15th the rarely sold securities in FARIX were "estimated" to be worth X by their valuation firm. This allowed them to price the fund at $9.20.
OK, But then what happened between then and September 22?
IF they sold lots of this "estimated" junk, when they sold it what it was worth, as it was marked to a market price..
( Why did it take till September 22 for them to "find" another price that they retroactively applied to the NAV on July 15?)
If it was not sold on July 15th, but many months later, how can you apply a "mark to market price" in September to a NAV in July?
I think a better explanation is there were lots of redemptions, and they paid them out, but when they finally unloaded some of this stuff, they didn't make the cash they wanted, so they went back and "Adjusted" the prices to allow them to be whole, not their investors.
https://sec.gov/Archives/edgar/data/1261788/000114554922056117/ncen-fulcrum.h
Is that what you received? I am not very familiar with this fund, but it is a statement from the fund's accountants, BBD, LLP: I do think this is a different situation from the one I'm describing from the sound of it, although the period the misstatement occurred was a volatile one.
IT is hard to understand exactly what they are talking about.
The quote still seems to refer to a position that cannot be valued daily in the market or else they were purposely misstating the price.
Hard to tell, but if they can "implement changes" to fix it, why are they allowed to retroactively change the NAV?