Fund stumbles as subprime market tumbles

Jim Kelsoe, a top-ranked junk-bond fund manager since 2000, dropped to last place this year because of losses tied to mortgages for people with poor credit.

Kelsoe's $1.1 billion Regions Morgan Keegan Select High Income Fund fell 4.2 percent from the beginning of 2007 through July 17 as defaults on subprime home loans reached a five-year high. The mutual fund had 15 percent of assets in the subprime market and at least the same amount in other mortgage debt in May.

The High Income fund got a boost from the holdings for seven years and now "it's very easy to be critical" of the investment decision, Kelsoe said in an interview from his office at Morgan Asset Management in Memphis, Tenn. The fund had as much as 25 percent of assets in subprime-related securities in 2005.

Kelsoe's fund ranks last of 93 high-yield rivals, and it was the eighth-worst performer this year of more than 550 U.S.-based bond funds tracked by Bloomberg. Losses accelerated in June after the collapse of two hedge funds run by Bear Stearns Cos. partly because of bad bets on bonds linked to subprime mortgages.

The $1 billion Regions Morgan Keegan Select Intermediate Bond Fund, which Kelsoe manages, also is the worst in its class, down 2.1 percent this year (through July 17) including reinvested dividends.

"A lot of mutual funds didn't own much of this stuff," said Lawrence Jones, an industry analyst at Chicago-based research firm Morningstar, referring to the subprime market. The Morgan Keegan fund "is the one real big exception."

Kelsoe said that, like fund managers drawn in by Internet stocks at the start of the decade, an "intoxication" with high-yield subprime investments kept him from pulling out completely.

Subprime mortgage bonds rated BBB, or investment grade, yielded 2.05 percentage points more than benchmarks in February, compared with 1.53 percentage points for BB-rated, or junk, corporate bonds, according to JPMorgan Chase.

Morningstar cut its rating on Kelsoe's High Income fund to three stars from four stars, citing above-average risk and underperformance. The highest grade is five. The fund has a one-year Sharpe ratio of minus 0.9, compared with 1.86 for its peers. A higher ratio means better risk-adjusted returns.

The average high-yield fund has gained 2.9 percent this year, as of July 17, according to Morningstar. The top-performing $4.1 billion Pioneer High Yield Fund, run by Andrew Feltus at Boston-based Pioneer Investment Management, has gained 9 percent.

Kelsoe's fund rose 17 percent in 2000, 18 percent the next year and 11 percent in 2002, outperforming 99 percent of its competitors. Since the start of the decade, the fund has climbed at an average annual rate of 12 percent, compared with 2.2 percent for the Standard & Poor's 500 Index of U.S. stocks.