Some Mutual Funds Primed For Subprime Fallout

Though most mutual funds have managed to steer clear of the subprime mortgage mess, some with heavy stakes in riskier and shorter-term bonds, asset-backed securities or sizable holdings of value stocks have particularly paid the price.

According to Paul Herbert, senior mutual fund analyst with Morningstar, Fidelity has a number of funds that fall into the troubled asset-backed securities category.

One is the Fidelity Ultra-Short Bond fund, which has about $785 million in assets. The fund has a 37.1% weight in asset-backed securities; as a result, its total return is down about 3% year-to-date, according to Morningstar.com. (Weightings are as of Sept. 30, according to Morningstar.com). Compared with benchmark index, the Lehman Brothers Aggregate Bond Total Return Index the fund is down 7.7 percentage points.

Fidelity Short-Term Bond Fund has also been impacted, though to a lesser extent. This fund, with assets of more than $7.31 billion and about a 16.3% weighting in asset-backed securities, has ticked up about 1.5% this year. Compared to the Lehman Brothers Aggregate Bond Total Return Index, however, it is down about 2.3 percentage points.

"The downside has been pretty severe," says Herbert, who notes that these funds were pretty good holdings prior to the subprime mortgage meltdown.

There are also a handful of smaller bond funds that have suffered. Topping the list is the $291 million Regions Morgan Keegan Select High Income Fund, which has been among the worst performers in 2007. Year-to-date, this fund, which has a 28.25% in asset-backed securities, is off more than 48%.

In terms of equity funds, those skewed toward value as opposed to growth stocks are among the biggest losers, largely because value funds tend to be more exposed to financial services companies, many of which have taken big hits from the subprime crisis. This is particularly true for funds that have large weightings in stocks of certain mortgage lenders or mortgage REITs. Shares in some of these have suffered double-digit losses.

Morningstar's Herbert points to a few big losers. One is the Weitz Value Fund. This $2.59 billion fund is down 7.2% year-to-date and 14.7 percentage points below the S&P 500 Total Return. Meanwhile, the $1.76 billion Weitz Partners Value is off nearly 5% year to date.

Compared with the S&P 500, it is down 12.5 percentage points.

A big problem for these funds has been their holding in Countrywide Financial, which has fallen more than 65% this year. As of June 30, both of these funds had more than 6.6% of net assets invested in Countrywide.

The Schneider Small Cap Value fund has also taken a bit of a hit.

With just $97 million in total assets, this fund has fallen about 16% year to date and is down more than 23 percentage points compared to the S&P 500 Total Return. Much of this fund's woes are due to the 4.66% position it held in the now bankrupt lender American Home Mortgage Investment Corp.

While subprime issues have hurt the performance of these funds, Stephen Wood, senior portfolio strategist with Russell Investment Group said that the subprime market isn't entirely to blame.

He believes that some of these funds may have been affected anyway. Value funds, for example, have been losing favor with investors over the past year, largely because the slowing U.S. economy makes large-cap, international and growth oriented stocks more attractive.

So what can you as an investor do to try to shield yourself in the future from major fallout in any one area of the market?

According to Wood, the best thing is to stick to the tried-and-true method of having a well-diversified portfolio, as this will protect you from significant losses if a certain segment of the market takes a major blow.

When the stock market is taking off, diversification may seem like a waste of money. However, when the market turns sour and becomes very volatile, that is when sticking with a strict discipline will really pay off, he said.