U.S. funds investigated over Puerto Rico bond strategy

Reuters

By Svea Herbst-Bayliss and Tim McLaughlin

BOSTON, Oct 9 (Reuters) - U.S. mutual funds that loaded upon Puerto Rico bonds, including OppenheimerFunds, are now thetarget of an investigation by a state securities regulator, whosays investors may not have been aware of their exposure to theisland's fiscal crisis.

The probe by Massachusetts' top securities regulator couldspark other investigations because many other state-specificmunicipal bond funds include Puerto Rico debt in theirportfolios, according to analysts. The bonds are exempt fromfederal, state and local income taxes in all U.S. states, makingthem attractive to mutual fund managers across the country.

William Galvin, the Massachusetts Secretary of theCommonwealth, said he is investigating three large fundmanagers, Fidelity Investments, OppenheimerFunds, a unit ofMassMutual Life Insurance Co. and UBS Financial Services, to determine how they sold mutual funds with heavyconcentrations of Puerto Rico debt and how they disclosed therisk.

"Puerto Rican bonds are like sugar in a bakery product. Theyare always included. Now the question is just how much and whatwere investors told," Galvin told Reuters.

The three funds companies were the first to receive inquiryletters from Galvin's office, though other fund companies putPuerto Rico bonds in their mutual funds. Fidelity and UBSdeclined to comment on Galvin's investigation.

OppenheimerFunds, in a statement, said its Puerto Ricoinvestments are disclosed and discussed at length in the funds'public disclosures. The company also said it is cooperatingfully with Galvin's inquiry.

Galvin said the companies have a few weeks to respond on howthey disclosed the risks associated with Puerto Rico debt.

Puerto Rico bond prices have been in a free fall amidrenewed fears about the island's chronic deficits, free spendingand high unemployment. The S&P Municipal Bond Puerto Rico Indexis down 19 percent in 2013. The index is badly underperformingthe S&P National AMT-Free Municipal Bond Index, which is downonly 3.6 percent this year.

OppenheimerFunds' Rochester municipal bond funds have beenamong the most aggressive in the industry with their heavyconcentration of Puerto Rico debt. The $69 million OppenheimerRochester Massachusetts Municipal Fund, for example,has nearly 17 percent of its assets in Puerto Rico debt,according to Lipper Inc, a unit of Thomson Reuters.

Galvin's investigation centers on determining the extentMassachusetts' investors were adequately made aware of the risksassociated with their investments, Galvin said in a pressrelease. The debt obligations were typically sold through amutual fund, he said.

"Puerto Rico is currently on the verge of insolvency andmany of its obligations are at or near junk rating, thus therisks associated with its municipal debt obligation aredisproportionately high," Galvin said in a statement.

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