Roanoke Times
Copyright (c) 1995, Landmark Communications, Inc.
DATE: SUNDAY, April 15, 1990 TAG: 9004110529
SECTION: BUSINESS PAGE: A12 EDITION: METRO
SOURCE: David Henry Newsday
DATELINE: NEW YORK LENGTH: Long
What Mills did not know was that his retirement money was riding on junk bonds, which bring high risks along with their high yields. Since last September, even as the dividend checks were rolling in, Mills' nest egg was being eaten away by the collapse in the junk-bond market.
Mills said neither he nor his wife suspected that he was making a risky investment. "All I was listening to was him telling me that he could put me into this particular company where I could gain 11- or 12-percent interest," the 60-year-old Mills recalled of his meetings with a First Investors salesman. "He assured me that there was no way I could lose because my money was covered by 250 different companies, and that if one goes down, the others will pick it up."
But starting late last summer, the market for those bonds was thrown into turmoil as Campeau Corp.'s department stores and other corporate debtors started defaulting on their bonds, and as savings and loan associations began dumping junk bonds under orders from the government.
The net asset value, or price, of the shares in Mills' fund fell from around $6 in September to about $4.75 when he got out in March. By then he had only $37,000 of his $50,000 left, and that was after reinvesting about $9,000 in dividends. He complained to his salesman, Hy Morgenstein, but to no avail.
Morgenstein says Mills was dreaming if he believed he could not lose any money. "I never said that," Morgenstein said. "People love to hear what is great for them."
Mills, mutual fund experts say, is typical of hundreds of thousands of small investors who were lured by high yields and are only now realizing that they had invested in junk bonds - corporate debt that no independent rating firm has deemed to be of "investment grade." Such bonds usually pay higher interest rates to compensate investors for the risk of default.
Junk-bond funds are the specialty of First Investors, a Manhattan-based mutual fund management company that has found some of its greatest success selling to people in the New York City area, often to blue-collar individuals who had been visited at home and persuaded to invest. Brokers' leads to investors tend to come through relatives, friends and people met in door-to-door calls on small businesses.
High yields do not mean much if the net asset value of a mutual fund falls. In most junk-bond funds, the collapse in their share prices over the past year has now cost investors more than the income those bonds have generated.
For the 12 months through February, junk-bond funds tracked by Lipper Analytical Services Inc., a brokerage, had an average total return of negative 7.92 percent. That is a dramatic change from the nearly 11 percent annual total returns the funds averaged in the 10 preceding years through September.
"A very large portion of the people who own these things shouldn't," said Tyler Jenks, head of research at Kanon Bloch Carre & Co., a Boston-based consulting firm specializing in mutual funds. "They tend to be retired folks. They've put a large portion of their assets in these, and they are living off the checks."
Until recently, junk-bond funds had at least continued paying high yields, even though their net asset values had plunged. But now, investors are beginning to see their monthly dividend checks reduced as well. More than 40 percent of junk-bond funds have announced dividend cuts since October; Jenks said more will follow. The average dividend cut was 15 percent.
Of all the investors in the nearly 90 junk-bond mutual funds on the market, those most likely to be caught off guard by losses are those in the funds operated by First Investors Corp., Jenks and others said. They said the company emphasized high yield in its sales pitches, seldom mentioning total return or risk.
"They are the ones that have reached for years for the junkiest of junk in order to pay the highest monthly checks. It made it easier for the brokers to sell them," Jenks said. "Basically that's a firm that has been built on selling junk-bond portfolios door-to-door to unsophisticated clients by unsophisticated brokers."
Sales representatives are encouraged to go to the homes of prospective customers. "That's where people are most relaxed, in their own setting," explained one former sales representative.
Liz Zazecki, a spokeswoman for First Investors Corp., which manages the funds and hires the sales force, said company executives declined to be interviewed for this story.
Bonds in First Investors' funds were among those that fell the most when the market collapsed. For the past 12 months, total return for First Investors High Yield Fund was negative 14.57 percent. Total return for First Investors Fund for Income was negative 14.76 percent, according to Lipper Analytical. The two funds ranked 76th and 77th, respectively, out of 85 funds surveyed by Lipper. Both were invested almost entirely in junk bonds.
Compounding the lousy returns are First Investors' onerous sales charges. Many of the sales are made under periodic payment plans that call for monthly investments; on payments of $50 a month, under a 10-year contract, commissions and expenses amount to 10.75 percent of the payments. That is well above average for mutual funds.
Yet the two are among the biggest junk funds in the mutual-fund industry. At year's end, according to Lipper, First Investors Fund for Income ranked fifth-largest among 89 junk funds, with $1.3 billion of the $28 billion in assets held by all the funds. First Investors High Yield Fund had another $750 million.
More than 220,000 people held shares of the Fund for Income, called "Fifi," at the end of September, as the junk-bond market began to fall apart. The High Yield Fund had 104,000 shareholders. The two funds are by far the biggest, most widely held and traditionally the most intensively sold of First Investors' mutual funds. Their prominence, says former First Investors representative Cindy Bremer, is a result of the company's emphasis on yield.
First Investors played a significant role in the development of the junk-bond market. In the 1970s, Fifi was one of the first mutual funds to buy junk bonds in quantity from Michael Milken, the Drexel Burnham Lambert trader who made junk bonds the prime financing tool for the biggest takeovers in history before he was indicted last year for securities frauds.
To its sales force, First Investors played that relationship with Milken for all it was worth, said Morris Daddona, a former First Investors salesman who counts himself among the victims of the company's sales pitches. Daddona would repeat stories he had heard at sales meetings to his potential investors. "I would tell them that we get such cheap prices on these bonds that it would save them money," he recalled.
Now two of First Investors' former junk-bond portfolio managers, David Solomon and Ben Bayse, are reportedly subjects of a government investigation into kickbacks from Milken for buying bonds with their investors' money.
Today Daddona, a tax accountant who once ranked among the top 20 First Investors representatives, grimaces and gets angry as he remembers putting his own retirement money and that of friends and accounting customers into the company's funds. He even invested his mother's $10,000 savings in a First Investors fund touting a high yield. "She was my first client," he lamented.
Now, trying to atone for what he did to customers of First Investors, Daddona said he relies on independent research and funds with more realistic yields.
"When I left, not one of my clients had made money," he said. He remembers one particularly angry client. "He hates me now," Daddona said. "He said Morris lied, and Morris did lie."
by CNB