Morningstar Advisor - April/May 2009 - (Page 37) Short-term investments might include money-market funds, commercial paper, Treasury bills, or a third-party managed portfolio that is being held as collateral for a position that is being lent to a third party. Call the fund manager for an explanation if you find anything labeled short term that doesn’t have sterling credit quality and a reliable ultra-short duration. Also, call the manager if you find anything listed as short term that involves mortgages and asset-backed securities of any kind. Add up the fund’s low-risk short-term investments and subtract the amount from the fund’s liabilities. Any amount remaining can be considered economic leverage. Liabilities Short-term holdings Amount of economic leverage $326,497,869 $55,037,109 $271,460,760 20.6% 3.5% 17.1% 3. If there is nothing labeled short term in the portfolio, the difference between total investments and total net assets is the fund’s economic leverage. Roadblocks Too often, you’ll come across a poorly organized Schedule of Investments that looks something like this example. The fund’s total net assets are listed in a footnote. It would be easy to miss that this fund was nearly 100% leveraged. Total short-term investments (cost $418,335,604) Total Investments $418,355,604 Total investments (cost $4,202,952,470) *Percentages indicated are based on net assets of $2,133,059,239. $4,202,528,432 How to Find Off-Balance-Sheet Derivatives Leverage Goal Identify and reconcile derivative exposures. Verify whether the fund’s net long exposures are offset by on-balancesheet positions. A net long position indicates that the manager is taking on extra risk beyond the balance sheet. Instruments whose value is based on another security or benchmark. Because derivatives investors typically only put up a “nominal” amount of initial margin to gain far greater exposure to the market, derivatives and balance-sheet leverage both share the same risk/return-magnifying properties. Funds list derivatives after the Schedule of Investments, but they often show up at the end of other financial statements and notes. Don’t pay attention to the stated “value” of these contracts. These are typically zeroed out at the end of each month, quarter, or other frequency depending on the contract. Derivatives’ “notional” amounts tell you the amount upon which contract payments and exposures are calculated. Because derivatives are contracts and not considered holdings or investments, they do not appear on the balance sheet and are not added to the fund’s net assets. MorningstarAdvisor.com 37 What It Is How to Gauge Exposure http://www.MorningstarAdvisor.com
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