Oppenheimer's Bond-Fund Blowup: Worse Than You Think

OppenheimerFunds' bond funds had a brutal year in 2008. As you can see in the table at the bottom of this post, their performance, in a word, was abysmal. But as distressing as the funds' losses were, perhaps even more disappointing was Oppenheimer's lack of candor in communicating to their fund shareholders just what sort of strategies they were using -- strategies that led directly to the staggering losses the funds endured.

Oppenheimer's Core Bond fund -- presumably suited to serve as an investor's core bond holding -- lost nearly 36 percent last year. But that return looks stellar compared to their high yield Champion Income fund, which was off more than 78 percent.

Together, Oppenheimer's taxable bond funds lost 24 percent in 2008, earning them an average rank in the bottom quartile of their Morningstar categories. Their municipal bond funds did even worse, falling by an average of 32 percent for the year.

At their core, bond funds have one primary mission. Most investors don't place them in their portfolio to provide dazzling returns, or to give them with something to brag about at cocktail parties. Most of us own bond funds, simply, to provide our portfolios with an anchor when the stock market storms are raging.

To state the obvious, the Oppenheimer funds didn't provide the sort of performance their investors might have expected -- or needed -- last year.

So how did it happen? Well, it seems that the funds, by and large, ramped up exposure to the sort of securities and sectors that got clobbered. A recent Morningstar analysis found that the Champion Income and Core Bond fund loaded up on mortgage-related debt early in 2008, and were also exposed to credit default swaps issued by AIG, Lehman Brothers, and Wachovia. Even worse, the funds essentially used leverage to increase the amount of these securities they could own.

Of course, gunslinger money managers are nothing new. And if you decide to invest with one, you expect to endure more than your share of volatility -- it goes with the territory. (Indeed, the year-to-date returns of a few of Oppenheimer's municipal bond funds indicate that some of the bets that cost their shareholders dearly last year are paying off this year.) It will almost assuredly take years before investors in some of these funds recoup their losses, if they ever do, but if that sort of whipsawing roller coaster ride appeals to you, more power to you.

But if any of the Core Bond fund investors might have expected such a ride, it wasn't because they read the fund's annual report, which contained no mention of the sort of strategies the funds were engaging in. According to Morningstar, there was nothing in the annual report that would have alerted shareholders to the amount of risk they were assuming. As Morningstar wrote, "[t]he only way to figure out what really caused all that damage was to go through the fund's legal filings line by minute line."

Among the investors surprised by the funds' volatility is the state of Oregon, which filed a lawsuit against Oppenheimer on April 14, claiming that the Core Fund's "plainly inappropriate" investments caused investors in the state's 529 savings plan to lose more than $36 million. In a statement, Oregon Treasurer Ben Westlund said that "Families were doing the right thing and saving for college, but unknown to them or Oregon, their money was invested in ways that were plainly inappropriate."

You might wonder just what Oppenheimer was telling its investors in the midst of this storm. Instead of clearly and candidly describing the funds' strategies, as you might expect, Oppenheimer President John Murphy was telling them that "OppenhiemerFunds has consistently focused its business on one main tenet: do what's best for our shareholders" (from the January 31, 2008 Semiannual Report for Rochester National Municipals) and that "our expectations are for a very modest rebound in the second half of 2008 . . . . you need to realize that you're in good hands" (from the July 31, 2008 Annual Report for Rochester National Municipals).

Unfortunately, with 2008 in his rear view mirror, Murphy made no mention of the funds' terrible performance in his letter in Core Bond Fund Annual report, dated December 31, 2008. The report does contain a brief (two question) Q&A with the fund's managers. In it, shareholders are told that "the most significant factors influencing Fund performance... were the volatility of the markets for fixed-income securities... and... the Fund's investments in the high-quality commercial mortgage-backed securities sectors and long-maturity fixed-income securities of highly-rated financial institutions."

Well, thank goodness they were only investing in all of those high-quality securities and highly-rated institutions, or things might have been really bad.

Does that sound like an attempt to communicate clearly and candidly with the shareholders who have entrusted Oppenheimer with their hard-earned assets? Does it sound like an attempt to be accountable? To ask the question is to answer it.

When you hear people decry the failure of mutual fund managers and directors to fulfill the fiduciary duty they owe their fund shareholders, this is precisely the sort of thing they're talking about.