Excessive Risk: Corporate and Municipal Bond Funds

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Cornerstone Research was retained by counsel for a family of corporate and municipal bond funds that suffered sharp declines in net asset value in the wake of the financial crisis.

A family of corporate and municipal bond funds (Funds) suffered sharp declines in net asset value (NAV) in the wake of the 2008 financial crisis. Investors claimed the Funds had failed to properly disclose the excessive risks of investments made during 2006–2007 in allegedly volatile securities and derivatives, such as dirt bonds, tobacco bonds, inverse floaters, credit default swaps (CDS), and total return swaps.

The Funds’ counsel initially retained Cornerstone Research to assess potential exposure, address plaintiffs’ allegations, and assist in mediation discussions. We also supported Professor Christopher James of the University of Florida and Professor Erik R. Sirri of Babson College, who submitted expert reports rebutting plaintiffs’ class certification and damages arguments.

Our experts determined that the Funds’ NAV declines were primarily due to the unprecedented 2008 financial crisis, and subsequently rebounded or surpassed pre-crisis levels.

Working with our experts, we analyzed the Funds’ position-level holdings and transactions data, demonstrating that the Funds’ actual portfolio composition was within the investment policy guidelines. We also showed that the allegedly volatile securities and derivatives accounted only for a fraction of the NAV declines and, had the Funds invested in other securities, they would have still suffered sharp declines in NAV.

Our analyses demonstrated that the Funds followed a strategy of exploiting the term spread (investing in longer-duration bonds) and the credit spread (investing in lower-rated investment-grade bonds). This strategy exposed the Funds to greater short-term fluctuations in NAV, which was compensated for by higher returns in the long run. We also established that this strategy was fully disclosed and well understood by market participants.

Our experts determined that the Funds’ NAV declines were primarily due to the unprecedented 2008 financial crisis, and subsequently rebounded or surpassed pre-crisis levels.


For additional information on this case, please contact Frank Schneider or Nari Subramanian.

Christopher M. James

William H. Dial/SunBank Eminent Scholar in Finance and Economics,
Warrington College of Business Administration,
University of Florida;
Senior Advisor, Cornerstone Research

Erik R. Sirri

Professor of Finance, Babson College;
Former Director, SEC Division of Trading and Markets;
Senior Advisor, Cornerstone Research