Vulnerable bonds

NEW YORK – Mutual fund investors who looked to counter their stock holdings with a conservative footing in bonds might understandably feel betrayed by recent headlines warning of cracks in the credit markets and threats to the values of some bonds.

But before hastily selling bond funds over fears that ruptures in subprime mortgages will prove ruinous to their holdings, investors should first examine what they own and consider whether their investments are showing signs of distress.

Subprime debt is tied to borrowers with poor credit, many of whom took on home loans when the housing market was stronger and are now having trouble paying their mortgages.

Making matters worse for investors, many of these mortgages have been bundled together and sold as securities. Some of these securities are complex, making it hard to determine who might be holding some radioactive debt.

Recently announced write-downs at companies like Citigroup Inc. and Merrill Lynch & Co. have rekindled investor concerns that more pain is to come.

But analysts note that not all subprime debt is bad – particularly debt issued before 2006, when some standards grew lax – and that not all of this debt is going to go bad. So investors seeking some assurance can do a little digging to try to determine the soundness of their funds’ financial footing. And, observers say, signs of trouble would in most cases have already started to appear through lower returns in recent quarters.

“It should be pretty obvious by now looking at returns if your fund is exposed in any meaningful way to these securities,” said Scott Berry, senior mutual fund analyst at investment research provider Morningstar Inc.

Berry contends investors would start to have seen second-quarter, third-quarter and year-to-date numbers fall off if there were major problems in a fund. But he also said investors can do some homework given the uncertainty that persists on Wall Street.

“The story is not over yet,” said Berry. “There is going to be more volatility and more chapters to come but at the end of the day we still don’t know what these things will be worth.”

Investors should keep in mind, however, that many funds wouldn’t necessarily be directly affected by faltering subprime debt. Some of the concern has been overblown, said Lincoln Anderson, chief investment officer and chief economist at LPL Financial Services.

“When you take the typical bond funds they don’t have much exposure here because it isn’t a very big piece of the credit markets,” said Anderson, referring to subprime debt.

“Most bond funds are still in, you know, 3 to 4 percent year-to-date returns. I don’t think they’ve got a whole bunch of hidden secrets in there.”