Looking at Fidelity's "Ultra-Short" portfolio

It's been many years since I've looked inside a prospectus or an annual report of a US mutual fund. Indeed, what is there to look for? The fund name and its classification on a site like Morningstar.com gives you an idea of what it is supposed to invest into, and if you are curious what it actually is investing in, you can just see the top holdings on Morningstar. So why bother with the prospectuses? A few days ago I was reviewing with a friend the list of mutual funds her 401(k) provider, Fidelity, was offering. "Well, stock funds invest into stocks, bond funds invest into bonds... With a long bond fund you'll get a higher current yield, but a risk of a greater capital loss when the interest rates go up; with a medium, or short bond fund, the current yield and the risk of a capital loss are both smaller. Oh look, they offer an Ultra-Short Bond Fund - that ought to be just like a money market fund, similarly low yields, but practically no potential for capital loss. Let's see what their record is actually like..." Well, it turned that Fidelity Ultra-Short Bond Fund (FUSFX) has had quite a remarkable record: while bringing positive returns comparable to the (low) short-term interest rates most of the time, it managed to lose about 15% of its net asset value during the period of about 2 years in 2007-2008. How do "normal" bond funds - that is, fund that invest into bonds (corporate or government debt obligations, or repackaged mortgages) lose money over a particular period of time? Well, there could be several possible reasons for a loss: * Bond issuers defaulted on some bonds * The perceived risk of default on some bonds increased, and the market value of the said bonds correspondingly dropped, even if no actual default happened * Current interest rates rose, so the market value of longer-term bonds correspondingly fell The first situation, of course, signifies a permanent loss, The second and the third situations are, in a sense, a "recoverable" loss: if you hold a bond to maturity, you still will get your principal back, plus the interest, so a fund that does not need to sell its holdings well eventually get its NAV back to the pre-drop position. So with a truly short-term bond fund such problems normally should not be an issue. So what ever happened to FUSFX during the financial crisis and market meltdown in 2007-2008 - did some 15% of the bonds in their portfolio default? That would be a remarkable thing indeed. The fund's current prospectus (2011-02-11) and annual report (2010-07-31) do not contain much of anything that would allude to the circumstances of the events of 2007-2008. "The fund seeks to obtain a high level of current income consistent with preservation of capital"... "investing at least 80% of assets in investment-grade debt securities"... "similar overall interest rate risk to the Barclays Capital 6 Month Swap Index".... "dollar-weighted average maturity of two years or less." There is this, "Engaging in transactions that have a leveraging effect on the fund, including derivatives", which of course can leverage the fund either way... and yeah, "Derivatives include ... credit default swaps (buying or selling credit default protection)." But the list of fund's holdings in its current annual report contains no such instruments - just a boring list of government and corporate bonds and mortgage securities. It took some effort to locate the fund's old annual reports or investment holdings lists at EDGAR, but when I found one (holdings as of October 31, 2007 ), it made for a surprising reading. After a long list of debt obligations, an inconspicuous section followed, called "Swap Agreements", and full of "Credit Default Swaps". What kind of animal is that? Well, here's one of the many items of this kind that the fund's portfolio contained at the time: * Receive monthly notional amount multiplied by 3.86% and pay Morgan Stanley, Inc. upon credit event of Merrill Lynch Mortgage Investors Trust, Inc., par value of the notional amount of Merrill Lynch Mortgage Investors Trust, Inc. Series 2006 HE5, Class B3, 7.32% 8/25/37 * Expiration date: Sept. 2037 * Notional amount: $600,000 * Value: $(504,664) (that's negative half a million dollars). This is, how I understand it, this works. Morgan Stanley bought a fairly high-interest (7.32%) and long-term (matures in 2037) mortgage-based bond from Merrill Lynch. Being clever enough, they understood that something may happens over the next 30 years, so they went to Fidelity and bought an insurance against the default of that bond. That is, Morgan Stanley would give up part of the interest payments they received on the bond (I suppose they really meant 3.86% per year - that is, over half of the entire interest - rather than per month, since the latter would just make no sense, even in the depth of the credit crunch), and Fidelity (actually, this particular Fidelity mutual fund) would reimburse Morgan Stanley for any losses incurred if Merrill Lynch (or, actually, the underlying mortgages) were to default. Apparently a default, or near default did happen, since the value of the contract with the notional value of $600K is shown to be a negative $504K. Now, half a million dollar loss is almost nothing for a billion-dollar fund, but the fund had quite a few contracts like this, as well as some interest-play instruments (total return swaps), with the "nominal" of $8M and the total value, as of that moment, of minus five million dollars. This, apparently, was already after some of that portfolio had been liquidated: an earlier (Oct 31, 2006) report shows quite a bit more of those, with the total nominal of $18M of credit default swaps and $9M of total return swaps, and a slightly positive total value. Besides playing an insurance company and insuring other companies against the default of third parties, FUSFX owned a good load of such bonds outright. About 30% of their assets at that moment was in "Asset-Backed Securities", some of which apparently, were in the dire need of insurance themselves: e.g., quite a few obligations from the "Accredited Mortgage Loan Trust" or "ACE Securities Corp. Home Equity Loan Trust" were shown as valued at 10-30% below the face value, and a few had lost over 2/3 of their value. So basically here we have it: a mutual fund with a mandate for preservation of capital gorges on some subprime mortgages with 30+ year maturity, and as if that's not enough, insures other companies against the default of similar instruments that they have. The net result, the "ultra-short bond" fund loses about 15% in a two-year period, while Fidelity's regular bond funds (including the GNMA one) are doing reasonably alright over the same time frame. No wonder that soon after the 2007-2008 debacle Fidelity ended up changing the fund's manager. A lesson for consumers? Sometimes it may pay to look into you fund's recent annual report, and to understand what exactly the things in their portfolio are.


Phags-pa inscriptions in Qufu

Four Yuan Dynasty steles in Qufu's Temple of Confucius and Temple of Yan Hui with inscriptions in 'Phags-pa script. (Presumably in Mongolian, but I have no idea). Three of these tables were carried by some of these temples' twenty-five stone turtles,, and one was without such a pedestal. Click on any image for details and other views.

Top of a stele in one of the stele pavilions of Kong Miao. The Dade era (1297-1307)

Another Phags-pa stele in the same pavilion. Year 11 of the Dade era (1307)

Imperial edict about the protected status of the Yan Miao. Year 11 of the Dade era (AD 1307). Note a square (left top) what appears to be Phags-ps seal script. (This stele has no turtle, though))

Base of a stele with an imperial edict bestowing new titles on Yan Hui, in the Yan Miao. Year 2 of the Zhishun era (AD 1331)

Confucius' twenty-five turtles

If you are an Emperor of China, and need to demonstrate the strength of your commitment to the Confucian principles, how would you go about it? You can of course renovate or rebuild the Temple of Confucius, or that of his favorite disciple, Yan Hui (they do seem to catch fire pretty often). You can bestow a new honorary title on the great sage or his disciple. But whatever you do, you have to conclude by writing it up in stone, and putting the tablet on top of a stone tortoise (bixi). After all, did not Confucius say, "Place the tortoise in front of all the other offerings, because of its knowledge of the future"? ("龜為前列,先知也"; Li Ji, Li Qi 32) This gallery features the twenty-five imperial turtles, with tablets in Chinese, Mongol, and Manchu, that still stand in Qufu's Temples of Confucius and Yan Hui. Contributed by 16 emperors, these stone reptiles span nine centuries and five dynasties, and represent all styles of the bixi art, from the naturalistic tortoises of the early Song to the dragon-headed bixi of the mid-Qing. See also 'Phags-pa inscriptions in Qufu


In the Yellow Emperor's hometown

This January, I spent a few days in Qufu, Shandong. The city is mostly known as the hometown of Confucius, and the guidebooks, accordingly, spend plenty of space discussing the ''San Kong'' (Three Confucian [Sites]): the Confucius Temple, the Confucius Mansion, and the Confucius Cemetery. Qufu, however, is not only Confucius' hometown: the guidebook also had a few lines about something called Shou Qiu (寿丘, "Longevity Hill"), said to the birthplace of the Yellow Emperor, the legendary founder of the Chinese nation, and the adjacent tomb of his son Shaohao (少昊陵, Shaohao Ling). Not a lot of details though. I had a spare morning, so I decided to go an see what it's all about. The place is in Jiuxian village, on the east side of Qufu - about 4 km from the historical center (the old walled city, where the Confucius Temple and Mansion are). So if that's where you're staying, you can take a city bus (I think no. 2) to get to Jiuxian. That January morning I was walking though, as I wanted to see a bit more of the city outside of the center. Following the highway sign, I came to where Shaohao Tomb and Shou Qiu were supposed to be... but all you could see from the outside were a brick wall and a closed gate with a "beware of the dog" sign. But no, that wasn't all: you could also see the tops of two giant dragon-crowned steles rising high above the wall: That certainly was intriguing enough, so I went on a walk around Jiuxian, looking for something that was open. Nothing much was, though, at this early hour - they did not even seem to have a noodle shop or a mantou stall. A house in the main street was decorated with the text of some provincial regulations dealing with family planning - and I don't mean it was just a slogan or a summary painted on the wall (as I'd see all over the place in rural China): it was actually done in tilework, with an eye toward permanence: (Here's a close-up). Walking out of the village to the fields north of it, and then coming back toward where the giant steles had been seen, I saw the gates of another compound, now indeed labeled "Shaohao Tomb" (少昊陵, Shaohao Ling). Sure enough, there was a ticket booth, and the entry fee was a rather outrageous Y50 (about US$8 - more than a daily wage for an average blue-collar worker or a service sector worker in the area). I was the day's first visitor, and, considering the frosty weather, I would not be surprised if I turned out that day's only visitor. As the guidebook says, the Shaohao Tomb site indeed has a small pyramid (probably, just an earth structure faced with stones), and an earth tumulus next to it. I suppose the stone pyramid design is indeed unusual for China, but that's of course no Cheops Pyramid. This all of course was said to be a Song Dynasty site (ca. AD 1000-1100) - but, really, with a backhoe, a supply of stone blocks and a few hired hands I probably could build such a pyramid myself within a reasonable time frame. There was a small temple on site, and some no doubt ancient steles - some whole, some broken, but nothing that exciting for a comparatively casual visitor such as myself. And yes, there was a cage with a guard dog in a corner: Somewhat disappointed, out the Shaohao Tomb's gate I went... and saw the top of the big stelae still on the horizon, above the trees. The path went south for about 500 meters, through a small forest. The forest is said to have grown over the site where the Jingling Palace (Jingling Gong) - a temple for venerating the Yellow Emperor - is said to have stood during the Song days... so the giant steles must have been originally put in front of the temple. (The ancient Chinese tradition is for temples etc. to be facing south, so "south of something" means "in front of something"). Soon enough, the path did come to the northern gate of the same fenced site that I saw the first thing upon arrival in Jiuxian a couple hours before. So that was the Shou Qiu. Both gates were open now. My ticket said that it also covered Shou Qiu along with the Shaohao Tomb. However, it seems that, in winter at least, no ticket is actually required to enter Shou Qiu, so if you're visiting, you may just as well skip Shaohao and buying tickets, and just go to the more interesting Shou Qiu. Now, within the fence, I saw Shou Qiu in all its glory. There weren't all that many objects there - just two, really - but the size of them certainly warranted attention. The two giant steles, over 16 meters (50+ feet) tall, crowned with dragons playing with a pearl, rested on top of similarly giant stone turtles, over 6 m (20 feet long). I've checked on a few books later on, and, supposedly, the twenty-footer turtles and the steles were originally erected during the Xuanhe Era (1119-1125) of the Huizong Emperor, arguably the most famous emperor of the Northern Song Dynasty. A tragic figure, early in his reign Huizong saw the rise of the Jurchen barbarians of the far north, and probably welcomed them as a force potentially useful against the other barbarians, the Kidan, whose Liao Empire had been the Song's rival for two centuries. Alas, having destroyed the Liao, Jurchen did not stop for too long before destroying the Song as well, and Huizong ended his days in captivity somewhere not too far from today's Harbin. The book claims that Huizong had four steles (all on twenty-footer turtles? the book is silent about it) erected in front of the Jingling Palace, but, apparently, they did not keep standing for too long after the Jurchen conquest. (However, one of the steles does have text - two letters 庆寿, "Celebrate Longevity" - written over a century later, under the Yuan Dynasty. The other is still blank, is known as ''Wan Ren Chou Bei'' (万人愁碑, "The Sorrow of Ten Thousand People"), on account of its weight (over 300 tons) and the effort involved in its carving and transporting. I have no idea what happened to the other two steles, but the two we see today were put together, from many pieces, and re-erected in 1991 and 1992. The tortoises, at least their faces, seem to be in remarkably good condition, so I wonder to which extent they are the actual restored Huizong turtles, and to which extent they are modern work; but in any effect, the entire ensemble is impressive, and is certainly worth visiting if you are in Qufu.

P.S. Not that getting to Qufu was difficult before, but with the opening of the Beijing-Shanghai High-Speed Railway in July 2011, on which Qufu has a station, you can get there in style. Now the Yellow Emperor's pyramid and giant turtles are within 3 hours' train ride from any of Beijing, Nanjing, Shanghai, or Qingdao.