No replies to this topic

[johngeorge]

http://online.wsj.co...7382849795.html

Suits, Inquiries Arise
From Credit Crunch;
Assets Fall Off Sharply By JENNIFER LEVITZ
October 5, 2007

After a brief dip in August, shares of State Street Corp. recovered from fears about its exposure to the turmoil in the credit markets. But the saga may not have finished playing out.




The Boston financial-services giant, whose State Street Global Advisors unit handles $1.9 trillion in assets, is known as one of the largest managers of so-called passive investments -- including stock and bond funds designed to mirror the performance of broad market indexes.




But customers are fuming about losses they have suffered in State Street bond funds that are designed not only to track but also just beat the indexes. Customers believed they were low-risk vehicles. Instead, the funds made aggressive bets on mortgage-backed securities, derivatives and other investment exotica.


In the latest development, attorneys general in Alaska and Idaho are looking into possible legal action against State Street over losses their state retirement funds suffered investing in two "enhanced index" bond funds. Both states have dropped the State Street funds in question and say the funds veered wildly from their index benchmarks, which caused them to post losses over the summer.




Earlier this week, a unit of insurer Prudential Financial Inc. sued State Street over $80 million in losses that 165 retirement plans it manages suffered in State Street fixed-income funds. Prudential says State Street didn't disclose that its money was in "highly leveraged" investments.




The potential costs of lawsuits could be just part of State Street's troubles. Its enhanced-index funds are "actively managed" vehicles that typically carry higher management fees than plain-vanilla index funds, and investors appear to be dumping the enhanced-index funds. Assets in the company's five bond mutual funds are down 43% so far this year. Because State Street is paid based on the assets it manages, it could potentially cut its profits.




In 4 p.m. New York Stock Exchange composite trading, State Street shares were up 11 cents to $68.22.

State Street said the Alaska and Idaho employee retirement plans still have money invested in other State Street funds and "remain valued clients." The company said that "we are confident that we comprehensively and accurately communicated the investment objectives of the funds in which they were invested."

The Alaska attorney general is examining "whether or not the fund was in investments more risky than our board had been told about, and whether there's any liability to State Street," says Jerry Burnett, administrative services director for Alaska's Department of Revenue.




In Idaho, the Public Employee Retirement System had 5% of its $11.4 billion fund in State Street's Government/Credit Bond fund. Idaho declined to say what it lost, but according to Prudential -- which is taking legal action about the same fund -- that bond fund dropped in value by at least 12% in July and August.




"The returns on the funds were not what was expected from an enhanced-index fund. We are reviewing what occurred in this fund; it's a priority for us," says Brad Goodsell, deputy attorney general for Idaho.

The value of the money that about 1,100 Alaska state workers had invested through their defined contribution plans in State Street's Government/Corporate Bond Fund fell to $30 million on Aug. 23 from $36 million on June 30, according to Alaska revenue officials. By Aug. 24 -- when the board, in an emergency meeting, dropped the fund as an investment option -- the bond fund was down 18% for the year, officials say.

The states' and Prudential's losses show that individual investors may be facing hidden risks from the subprime and credit mess in their retirement accounts, and also highlight the proliferation and potential pitfalls of the unregistered and often opaque investment vehicles in some employee plans.




In Alaska, the bond fund was popular with employees in their 50s who were nearing retirement, and who wanted conservative investments that were a little better than a money-market fund, says Mr. Burnett. The recent loss, he says, "may delay retirement for some people, that's what we're talking about."

A "detail sheet" provided by State Street to clients for the Government/Corporate Bond Fund said the investor receives exposure to a "broad-based, investment-grade fixed-income universe." But as of March 31, the fund had nearly half of its weighting in mortgage-backed securities (25%) and other asset-backed securities (23%); such securities may be investment grade but are riskier than Treasurys and specific corporate issues. In September 2005, the same fund's biggest weighting was in U.S. Treasurys while mortgage and asset-backed securities accounted for less than 6% of its top 10 holdings.

Sean Flannery, the chief investment officer for State Street Global Advisors, wrote institutional clients on Aug. 14 that "in the midst of the recent turmoil in the fixed-income markets, many of our active bond strategies" had "sharply underperformed."




Mr. Flannery said the company had "focused increasingly on housing-related assets" to find attractive yields and said "the level of underperformance" was "unprecedented in our 30-year history as a fixed income manager." Further, State Street told institutional investors in a report that as of July 31, the Government/Credit bond fund was leveraged to nearly 6-to-1 -- meaning that the fund borrowed to increase its portfolio to about six times the amount of money clients invested. A footnote says the investments included Treasury futures, options on futures, interest rate swaps and interest rate "swaptions."




Alan Winkle, director of Idaho's employee retirement system, says "when we started to ask questions, they weren't able to give us a securities listing of where they were invested."




It isn't clear whether State Street's problems with customers go beyond Prudential, Alaska and Idaho. But assets are also dropping in the bond mutual funds the company manages. The company manages $11.3 billion in mutual funds, according to the Chicago researcher Morningstar Inc.




Assets in these funds have grown overall since last year. But State Street's five bond mutual funds have been bleeding assets, dropping 43% to $444.7 million as of Sept. 30, from $784.5 million on Dec. 31, 2006, according to Morningstar. Three of the bond funds are being beat by 99% of peers; another, the "yield plus" bond fund, is last in its category.