Is Your Fund At Risk?

Complex financial instruments called credit default swaps have roiled the financial markets for months. They're at the heart of the bond insurers' woes and were a reason why insurance giant AIG (AIG) just added billions to a planned writedown. But if you think exposure to these derivative securities is limited only to insurers and investment banks, take a good look at your seemingly bland, conservative bond fund.

Start with the world's largest, Bill Gross's $120 billion Pimco Total Return fund. Gross railed against credit default swaps (CDS) in his January investor newsletter, calling them securitized weapons of mass destruction. But the latest holdings for his bond fund, as of Sept. 30, show more than 300 CDS positions, some as large as $200 million.

Gross is hardly alone in dabbling in the swaps, which allow managers to get a bump up in yield as well as hedge their bond positions. Of the 30 largest bond funds, 12 have exposure to credit default swaps, including Oppenheimer Strategic Income, T. Rowe Price New Income, Western Asset Core Plus Bond, Vanguard Short-Term Investment-Grade, and four Pimco funds. Unlike some of the troubled CDS of late, the swaps in these mutual funds aren't necessarily related to subprime mortgages.

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