Are Subprime Woes Hitting Your Fund?

The subprime fallout has crept into the mutual fund world.

Bank loan mutual funds, which traditionally deliver steady single-digit returns, are getting pummeled this month as concerns about bad bets by some big players on subprime mortgages have spilled over into other kinds of loans.

Bank loans are loans to companies with below investment grade, or "junk," credit ratings. Unlike high-yield corporate bonds, which are typically unsecured, bank loans are backed by hard assets. They have become the preferred vehicle for financing buyouts by private-equity firms. This month, a leveraged buyout of General Motors' (GM Quote)'s Allison Transmission unit, with $3.1 billion in loans, was postponed, and the buyouts of Ahold's (AHO Quote) U.S. Foodservice unit and ServiceMaster(SVM Quote) also were shelved because the sponsors couldn't finance them cheaply enough in the loan market.

The average open-end bank loan mutual fund tracked by Morningstar fell 0.68% for the month ended Friday. That may not seem like much, but it surprises investors who have gotten used to dependable, if unspectacular, returns. This group has returned an annualized 5.40% over the past three years and an annualized 6.04% over the past five years. Participants say the bank-loan market has had no more than four down months in over the past decade.

Some closed-end funds have been hit particularly hard. The Pimco (PFL Quote)Floating Rate fund (PFL) registered a 1.3% decline in the value of its holdings for the week ended Friday, while the net asset value of a sister fund, Pimco's (PFN Quote)Floating Rate Strategy (PFN), declined by 1.39%.

The share prices of these funds fell even faster than the value of their holdings as investors headed for the exits, with Pimco Floating Rate shares giving up 12.5% from its recent high on July 5, while Pimco Floating Rate Strategy's shares are off 8.5% from their July 5 peak.