Foggy Area
One example of how difficult it is to discern what is going on with these funds is with the $994 million Western Asset Total Return Bond Unconstrained Bond Fund, which held about 17 percent cash as of June 30, according to the firm. But until Reuters pointed it out, Morningstar's data showed the fund had over 66 percent cash. Lipper showed that the fund held 90 percent in cash, but the company noted the fund was negative 75 percent in the "other" category.
The Western fund, which like many unconstrained bond funds uses future contracts and other derivatives widely, was not including the notional value of these contracts when determining the entire value of the portfolio, while Morningstar was including the negative exposure posed by these contracts, accounting for the discrepancy, said John Martin, a portfolio data specialist at Morningstar.
The problem is that every fund company discloses and values its derivatives differently, he said. "It's a foggy area," Martin said.
Western said it works with Morningstar and other data providers to make sure that the characteristics of its funds are accurately represented.
Morningstar changed the cash number for the Western Fund to 16 percent after Reuters discovered the discrepancy.
The U.S. Securities and Exchange Commission is working on a rule to standardize disclosure of how funds use derivatives.
Given the lack of transparency and the latitude that managers of these funds have, some advisers, like Josh Brown, chief executive officer of Ritholtz Wealth Management, are telling their clients to steer clear of these funds.
"Some of these funds will do well, and some won't," he said. "Based on the limited amount of knowledge about what they are doing, how can I possibly represent to my clients that I know which one is going to work?"