Trouble Brewing From Puerto Rico for OppenheimerFunds Bond Funds?

Big bets on Puerto Rican debt has sent the value of the Oppenheimer Rochester Virginia Municipal Bond Fund (ORVAX) reeling. As reported today by Investment News, the $125 million municipal bond fund is down more than 15% this year, ranking it dead last among single-state municipal bond funds and the second-worst among all municipal bond funds. By comparison, the average single-state municipal bond fund is down 5.58%.

“When you start getting bond fund losses in the 10% range, you’d better have a looming catastrophe,” Lee Munson, principal at Portfolio LLC, is quoted as saying in the Investment News article. “Short of a North Korean invasion of Virginia, losing 15% in a Virginia-specific bond fund is probably going to make people very upset.”

The key factor in the fund’s dismal performance has to do with bets on Puerto Rican bonds, which have drastically underperformed the broad municipal bond market. Oppenheimer Rochester Virginia Municipal Bond Fund held 33% of its assets in Puerto Rican debt as of Aug. 31, according to Morningstar, the most of any single-state municipal bond fund.

According to the Investment News story, the Oppenheimer Rochester North Carolina, Arizona, Massachusetts and Maryland funds are the only other single-state municipal bond funds that hold more than 25% of assets in Puerto Rican bonds. The median single-state municipal bond fund holds just 2.38% of assets in Puerto Rican bonds.

Each of the funds is down more than 11% year-to-date through Oct. 10.

Earlier this week, Massachusetts Secretary of the Commonwealth William Galvin launched an inquiry into the sales practices of bond funds with Puerto Rican debt and whether or not investors were made aware of the risks in the products. Galvin sent letters of inquiry to OppenheimerFunds, Fidelity Investments and UBS.

This isn’t the first time OppenheimerFunds’ bond funds have been scrutinized by regulators. In 2012, the Securities and Exchange Commission (SEC) charged OppenheimerFunds and its sales distribution arm of making misleading statements about two of its mutual funds. Specifically, the SEC’s investigation found that Oppenheimer used derivative instruments known as total return swaps to add substantial commercial mortgage-backed securities (CMBS) exposure in a high-yield bond fund called the Oppenheimer Champion Income Fund and an intermediate-term, investment-grade fund known as the Oppenheimer Core Bond Fund.

The Oppenheimer Core Bond Fund ultimately imploded, falling 35% because of its exposure to mortgage-related debt and credit default swaps.

OppenheimerFunds later settled the SEC’s charges for $35 million.