Brokerage to bail out bond fund

June 09, 1994|By New York Times News Service

In a virtually unprecedented bailout of a money-losing mutual fund, PaineWebber Inc. said yesterday that it would put $33 million into one of its funds in order to partly compensate investors for unexpectedly heavy losses.

PaineWebber's Short-Term U.S. Government Income Fund, which promised investors high returns with low risk, invested in various complex one-of-a-kind securities based on home mortgages. The fund performed well last year, but declined by 5.7 percent this year, including a 4 percent drop on a single day, May 6.

PaineWebber said it was taking the highly unusual step of partly bailing out investors because its marketing material for the fund had indicated that it did not intend to invest in these complex mortgage securities. But late last year, the fund increased holdings of these securities. And some of these securities were responsible for the bulk of the price declines.

PaineWebber's fund was promoted heavily by its brokers, who were able to persuade clients to invest $1.7 billion in it by the end of last year. Because of heavy sales by investors, the fund now has fallen to $1 billion.

Steve Brown, who was appointed to manage the fund last fall, was suspended in late April. The PaineWebber spokesman said the company was investigating whether Mr. Brown took any improper actions. The fund's original managers, Ellen Griggs and Edward Rosenzweig, will now manage the fund.

Several years ago, a few fund companies injected money to compensate for losses in their money market funds to keep their share price stable at $1. But this is the first time a manager has bailed out a mutual fund other than a money market fund, said John Rekenthaler, editor of Morningstar Mutual Funds.

"This is a defeat for the fund industry and a victory for the fund consumer," he said.

Last month, the Piper Jaffray investment firm, based in Minneapolis, said it would buy at least $10 million in a similar mortgage-backed security fund that had fallen in value. While the move was an expression of confidence that the fund's price would rise, it was not a bailout of the fund and did not compensate investors for their losses.

PaineWebber said it would take two actions to help investors in the fund. First it would buy from the fund about $160 million of the most volatile mortgaged-backed securities, known as "interest-only" and "principal only" securities.

PaineWebber said it would buy these securities at their fair market value, as determined by a computer model, and the net asset value of the fund would not change as a result.

The company also said that it planned to inject $33 million into the mutual fund, which would increase its net asset value by 6 cents a share. The fund's shares closed at $2.30 Wednesday, down from $2.41 on April 28.

PaineWebber said that this payment would be made within 90 days as part of a court-approved settlement of two class-action suits that had been filed by disgruntled investors.

Sam Schwartz, a lawyer representing one of the investors, Philip Horowitz, said PaineWebber's settlement was not adequate and that the firm should compensate investors for the 11-cent-a-share loss, rather than just 6 cents.

"PaineWebber has to make everyone whole," said Mr. Schwartz, a partner with Bizar & Martin.

"People invested in the fund because it was supposed to be only slightly riskier than money market funds and bank CDs. Instead they were investing in a go-go fund. And it didn't go."

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