U.S. dollar investment funds in Costa Rica began stabilizing this week after investors withdrew nearly 50% of the money from the funds in the past six weeks because of a volatile combination of dropping Costa Rican bond prices and investor panic.Between March 15 and Tuesday of this week, the amount of money managed by these funds dropped from $2.24 billion to $1.29 billion as more than 15,000 of a total 42,000 investors fled the market.Total capital and accumulated interest losses surpassed $123 million, according to the Superintendence of Securities (SUGEVAL).Several investors of Banco Nacional’s Crecifondo and Superfondo – two of the country’s largest dollar investment funds – said they were shocked to discover their original investment is not government insured.Three investors who spoke with The Tico Times – two U.S. citizens and one Costa Rican – had placed their money in Banco Nacional’s funds believing the Costa Rican government was insuring their original capital in the same way it insures savings deposited into accounts at state-run banks.A representative of BN Fondos, Banco Nacional’s investment-fund manager, clarified that the funds themselves are not insured. However, because Banco Nacional invests solely in government bonds, the assets its funds hold are insured by the government, the representative said.One investor, who asked not be named, said he also was shocked to find out BN Fondos charged him a fee to withdraw his money from the fund early.In response, Adolfo Rodríguez, Superintendent of Securities, has announced SUGEVAL will begin working on measures to improve the quality of the information investment-fund managers provide potential customers.THE drain on the funds was sparked by a drop in the price of Costa Rican Central Bank and Finance Ministry debt bonds, which in turn was caused by two main factors, according to the Central Bank and SUGEVAL.First, by the middle of March it was widely believed that Costa Rica’s bonds were overvalued in comparison to bonds issued by countries with similar risk ratings, such as El Salvador and Panama.Second, in recent weeks U.S. Federal Reserve Bank Chairman Alan Greenspan hinted the Fed would soon raise the interest rate at which it lends money to other banks, to keep the fast-growing U.S. economy from over-heating.Many investors feared higher international interest rates would reduce the profitability of fixed-income investments such as sovereign debt bonds.This sparked a wave of selling that hit Costa Rican investment funds particularly hard, according to Bear Stearns, a U.S.- based investment bank and brokerage firm. Rodríguez confirmed this last Monday. “WHEN interest rates increase [in the United States], the price of securities here drops,” he explained. “This affected all of Latin America.”The combination of these factors prompted “local bond holders to seek to protect their position or take profits before the correction took place. The trouble is that once the selling began, the local market’s herd behavior kicked in, quickly pushing prices down,” stated a briefing issued by Bear Stearns on April 28.The drop in bond prices adversely affected the Costa Rican funds, which, according to SUGEVAL, on average had invested 75% of their assets in Central Bank and Finance Ministry bonds. Some funds, including Banco Nacional’s funds, invest solely in Costa Rican government bonds.Danilo Montero, an economist specialized in investment funds who has worked for the National Stock Exchange, admits the holdings of Costa Rican investment funds aren’t very diversified.HOWEVER, he blamed Costa Rican investors, saying they traditionally have favored Costa Rican debt bonds over bonds issued by other governments or private firms, and not the fund managers, who according to Montero give clients what they want. He recommended that managers “educate” investors to demand more diversified portfolios.Scared by the initial losses, thousands of investors left the market, which forced fund operators to sell bonds to raise the money needed to repay the investors who wanted their money back.More bonds on the market led to an excess supply, which made the price of bonds drop even further. Lower bond prices meant even more losses for the funds, which prompted even more investors to demand their money.This downward spiral transformed what analysts had predicted would be a regular adjustment in bond prices into a larger phenomenon that dramatically reduced the earnings of dollar investment funds and devoured a sizeable portion of investors’ money.IN an attempt to protect the funds, SUGEVAL last week announced it would temporarily double the percentage of debt investment that fund operators are allowed to have, from 15% to 30%.Central Bank President Francisco de Paula Gutiérrez announced the Central Bank would extend a credit line to commercial banks that would grant them greater leverage with which to pay back clients who wish to withdraw their money from the fund without selling more bonds.If the situation continues, the Central Bank could begin buying back some of the bonds it issued to curtail the available supply of bonds.RODRIGUEZ and Montero said they expect the investment funds to recover. The fact that they had enough liquidity to respond to the crisis and give investors their money back was a sign of the stability of the country’s financial system, Rodríguez said.“It was a normal adjustment, a market adjustment,” Rodríguez explained. “It was larger than necessary as a result of the nervousness of many investors.”Montero said the funds could recover as soon as the Finance Ministry and the Central Bank make their next interest payments to the investment funds.How Investment Funds WorkA fund operator, usually a bank or other type of financial institution, creates an investment fund that receives money from investors. The money is used to acquire securities (in this case bonds) from governments and private companies.Each fund offers its own portfolio. In Costa Rica, investment funds are available in colones and dollars. There are shorttermfunds (liquidity funds) and long-term funds (growth funds). Long-term funds offer higher interest rates.Bonds are interest-bearing certificates issued by a government or a business promising to pay the holder a specific sum(in most cases some percentage above itsoriginal value) on a specific date.Governments and firms sell bonds to raise capital to cover expenses and large investments.Most bonds offer higher interest rates than regular bank accounts.Investors entrust the fund’s operators to invest their savings (original capital) inbonds, which, after a given time, are repaidalong with interest. This way, the investorsmake a profit in addition to what they originally invested, while the fund receives acommission.If all goes according to plan, the longer the investor stays in the fund, the more money he or she will make from interest payments on the bonds the fund invests in.However, as with all investments, even the safest investment funds – those that invest in relatively safe securities and are monitored by SUGEVAL – can lose value and eat up investors’ savings, the Superintendent reminded investors.
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