The 'Temporary' Unrated Paper and Bond-Like Preferred Shares
Harbor View Bond UITF's declaration of trust permits investment only in peso-denominated government securities, bank deposits, and corporate bonds rated at least BBB by an accredited rating agency. It also caps exposure to any single issuer at 10% of net assets. On 30 June the fund holds 12.4% in unrated three-year commercial paper issued by the parent company of the fund's investment manager, bought when a previous issue matured and the manager says it was 'temporary.' The fund also holds 7.9% in preferred shares of a property developer that pays an 8.2% dividend; the manager argues these are 'bond-like.' The fund's NAVPU has outperformed its benchmark by 90 basis points year-to-date. The compliance officer wants to force sales at a loss; the fund manager wants to wait for the commercial paper to be rated and for the preferred shares to be called.
1. Determine whether the unrated commercial paper and the preferred shares are eligible under the fund's policy.
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Neither holding is eligible. The policy allows government securities, deposits, and corporate bonds rated at least BBB. Unrated three-year commercial paper is not a rated corporate bond, and 'temporary' does not create an exception. The 12.4% position also breaches the 10% single-issuer cap. The fact that the issuer is the parent of the investment manager adds a conflict and may trigger affiliate or self-dealing restrictions.
The preferred shares are equity securities, not corporate bonds. An 8.2% dividend does not make them bond-like; dividends can be suspended, and the shares can lose principal. The property developer is outside the permitted asset list. The manager's hope that the paper will be rated or the shares will be called is not a cure. The fund must be managed according to its declared policy, and the compliance officer is right to treat both positions as breaches. Outperformance does not excuse an unauthorized investment.
2. How should the fund cure the breaches, and what valuation and governance issues arise?
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The fund should stop adding to either position and adopt a written cure plan with a short timeline. It should sell the unrated paper and the preferred shares in an orderly manner, using best execution and documenting the reasons for any delay. Waiting for a rating or a call is not acceptable because it keeps the fund exposed to ineligible assets and may extend the breach. If the market is illiquid, the fund should obtain independent valuations and sell in tranches without favoring the manager's affiliates.
The loss should be borne by the fund in the normal way; the manager cannot avoid a loss simply because it is uncomfortable. The trustee should review whether the affiliate purchase was approved, whether the 10% limit was monitored daily, and whether the valuation of the unrated paper was independent. The conflict should be escalated to the trust committee and compliance, and the fund should report the breach to the BSP if required. The manager's compensation and mandate should also be reviewed.
3. What should unitholders be told, and how should the fund present its year-to-date outperformance?
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Unitholders should receive a clear, timely explanation of the breach, the affected holdings, the cure plan, and the risk that sales may crystallize a loss. The disclosure should avoid minimising language. If the breach is material, the trustee should notify unitholders individually and update the fund's periodic report. The fund should not advertise the 90 basis point outperformance without explaining that part of the return came from out-of-policy holdings and may not be repeatable.
Performance reporting should remain based on the actual NAVPU, but it must be fair and balanced. Marketing should show the benchmark, fees, and the risks of the ineligible holdings. The fund should correct any impression that the manager's 'temporary' or 'bond-like' labels were approved. The trust committee should also consider whether the fund's name and objective still match its portfolio. Transparency is not just a regulatory formality; it protects unitholders who relied on the declared policy.