Thursday, May 21, 2009

Bond Funds Make PPIP-ing Noise

I must first begin by bringing you up to speed on a couple of terms that have been added to our financial lexicon. TARP was introduced last year as a way to finance troubled banks, keeping the largest financial institutions afloat while they worked out their problems. Dubbed TARP (Troubled Asset Relief Program), money was more or less forced on banks to instill not only confidence in the system but to give the lenders money to get the credit markets moving again.

The TARP program has shown signs of success. Critics have attacked the banks for not lending enough of the money or making the standards for lending far too tough for the average borrower. Some banks have attempted to give the money back, somewhat prematurely and long before they have shown that the problems on their balance sheets have been addressed. Another version of this program is about to be extended to smaller banks and commercial lenders.

One of the other challenges facing the Treasury is the problem assets that caused this financial meltdown. By soliciting private equity money to help and guaranteeing or matching private investment, the Public Private Investment Plan or PPIP was developed. While the economy is showing the initial signs of recovery, there are still a great deal of mortgage backed securities (MBS) and asset backed securities (ABS) floating around on various balance sheets with a need to be priced and sold. PPIP is offering private investors (more specifically, some of the largest fixed income mutual funds and hedge funds in the investment world) the opportunity to purchases these at a reduced risk.

Along with PPIP the Term Asset-Backed Securities Loan Facility, or TALF, will give some investors the opportunity to purchase securities that may prove to be bargain basement priced. Once these big investors (PIMCO, BlackRock, or Western Asset Management) begin to see some profits, the trickle down effect will take hold.

Who might this trickle down effect help? Right now, it is difficult to tell. There is still a long way to go yet if the program works, some funds that use bonds to offset risk might see some recovery in their portfolios. because these funds will likely be sold as closed end funds and not necessarily priced for the average investor, target-dated funds might find the opportunity to good to pass up.

According to Morningstar, the risks are still very real and may even be underestimated. They reported that "If asset managers get the impression that the government is unwilling or unable to guarantee contracts of mortgage-backed securities or protect asset managers from attempts to claw back some of the profits made through PPIP, we wouldn't be surprised to see managers back away from the program en masse."

When reviewing your fixed income portfolio, look for transparency on this particular side of the coin. The risk may be worth taking. But just as possible, it might not.

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