Just as unscrupulous teachers manipulate student performance to increase their own fortunes, so some mutual fund managers are over-pricing their bond portfolios to attract investors. Bond values are not easy to determine in the current atmosphere of state and municipal budget shortfalls and fewer tax receipts. Generally traders and portfolio managers prefer to rely on comparables for proper bond values but that is not always possible. The Securities and Exchange Commission has noticed the problem and started an investigation into how bond funds price risk in their portfolios.
Even during good times pricing bond values is more of an art than a science. With all the reports in the media about municipalities defaulting and states too poor to provide a safety net, investors have been selling off their bonds at a rapid rate. Even when fund managers use a third party to set values they can arbitrarily increase those values in their final reports. It happens more frequently as economic pressures increase as does the reluctance to show large losses. As pointed out by Robert Kane, founder of BondView LLC, which operates a website for muni bond investors, the bottom line is that “The municipal bond market is illiquid, and the funds that hold those bonds are subject to that same illiquidity”. These concerns were also expressed in an article by Jessica Toonkel in a recent edition of Investment News.
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