The following story appeared in Caribbean Business on October 16, 2013:
By John Marino
Local investors lost $2.25 billion last month through mutual fund investments in Puerto Rico government bonds and other island-based securities, according to statistics released Wednesday by the Office of Financial Institutions Commissions (OCIF by its Spanish acronym).
The value of Puerto Rico securities fell to $7.31 billion as of Sept. 30, compared to $9.56 billion the previous month, OCIF figures indicate.
The heavy losses have dried the market for closed-end mutual funds, which currently have little or no liquidity, Financial Institutions Commissioner Rafael Blanco said. The lack of liquidity is exacerbated by rules requiring the tax-exempt funds to only be sold to Puerto Rico residents.
So far this year, local mutual fund investments in Puerto Rico bonds and securities have fallen by $3.7 billion, OCIF figures indicate. When non-Puerto Rico securities are included, local mutual fund investments as a whole are down $4.52 billion so far this year.
“There is no hiding from this. It will have a huge effect,” economist Elias Gutiérrez said of the loss in local wealth.
“It will have a direct effect on investment. It will make potential investors more risk adverse,” he added.
Gutiérrez pointed to the “wealth effect,” an economic tenant indicating that the perception of wealth is also tied to consumption and spending trends, in arguing that it would also impact the broader economy.
“It will have a huge effect on consumption, aggregate demand and consumer behavior across the board,” Gutiérrez said.
Mutual fund Puerto Rico security investments are down 33.6% this year, while the broader mutual fund investment portfolios are down 28.72%, OCIF figures indicate.
Many local investors participating in leveraged closed-end mutual funds saw even larger losses, with many investors being “completely wiped out.”
Closed-end funds typically employ 50% leverage or use borrowed funds to double their assets. This boosts earnings when bonds retain their value, but magnifies losses when bond values drop.
While investors are barred by local securities law and investment firm policy from using borrowed money to buy closed-end fund shares, many brokers and investors used different schemes to get around the prohibitions, according to lawsuits filed on behalf of investors.
Several lawsuits have been filed and more are expected. The biggest target has been UBS Puerto Rico, a market leader operating 23 closed-end mutual funds that had total market capitalization of about $4 billion at their outset and make up about 50% of the firm’s revenue, according to the legal complaints. Since their inception, some funds have lost half their value or more. Popular, Inc. and Santander Securities also operate closed end mutual funds in Puerto Rico.
UBS Puerto Rico CEO Carlos Ubiñas said the business isn’t responsible for “market events.”
“The loss in value of Puerto Rico bonds is tied to market forces and continued doubts over Puerto Rico’s credit,” Ubiñas said in a statement. “The financial industry, and much less UBS, can’t be blamed for market events.”
In May 2012, UBS Puerto Rico agreed to pay $26.6 million to settle Securities & Exchange Commission charges it misrepresented and omitted material facts about its Puerto Rico closed-end bond funds.
Meanwhile, minority New Progressive Party lawmakers are pushing for investigations of UBS’ practices in Puerto Rico that have been drawing increased scrutiny after a selloff of Puerto Rico debt in recent months hit its wealth clients very hard.
Rep. Ricardo Llerandi Cruz has filed legislation seeking a Capitol inquiry into UBS. Rep. Ángel Muñoz Suárez said he will file a complaint with the federal Securities Exchange Commission over “dubious transactions.”