Mutual Fund Withdrawals Cost Investors

The Schwab YieldPlus Fund(SWYPX Quote) began to unravel in August 2007.

The fund lost 1.7% that month, a shocking development for a short-term bond portfolio that had been considered safe. The trouble started when portfolio managers tried to squeeze out more yield by investing in subprime mortgages. After seeing the losses, mutual fund investors dumped their shares.

Schwab(SCHW Quote) portfolio managers sold investments at discounted prices to raise cash to cover withdrawals, worsening the situation. The trickle of redemptions turned into a flood. The fund's assets fell to less than $300 million from $13.5 billion in less than in 15 months. Those investors who stayed aboard lost 42%, during the 12 months through February, according to Morningstar(MORN Quote).

Schwab was among many mutual funds companies forced to sell holdings in the face of mounting redemptions as the stock market collapsed. The move typically exacerbates the situation by hurting fund performance, prompting more investors to pull their money.

"During a downturn, managers are forced to sell at a time when they see lots of bargains that they want to buy," says Karen Dolan, Morningstar's director fund analysis.

In the past year, investor withdrawals have sapped more than 70% of the assets of the JPMorgan Bond(JMIBX Quote), Morgan Stanley Balanced(MPBAX Quote) and PIMCO StocksPLUS TR Short Strategy(PSTIX Quote) funds.

Forced selling has taken a severe toll on short-term bond portfolios, including the AMF Ultra Short(AULTX Quote), Metropolitan West Ultra Short Bond(MWUSX Quote) and Fidelity Ultra-Short Bond(FUSFX Quote) funds. The funds' managers sold corporate and mortgage-backed securities after their values had plunged, locking in losses they can never recover.