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BUSINESS
In recent years, more mutual funds have used borrowed money to juice returns and lure investors. Now, they are discovering the
downside of leverage, and some are cutting back.
Early last year, Wall Street was heavily promoting several new types of funds that rely on borrowing money. These include so-called
130/30 funds that aim to amplify market returns by betting against some stocks, as well as "leveraged index" funds, which promise to
double the return of a market index or double its inverse.
At the same time, closed-end funds, many of which have used leverage for decades, were growing rapidly until 2007.
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Under Pressure
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However, this strategy came under pressure early last year, as their main route for borrowing, auction-rate securities, froze up. Since
then, the closed-end funds have been paying higher rates on their borrowing.
Later in the year, as net asset values declined, several funds had to deleverage or get rid of borrowing entirely to meet legal
requirements. Closed-end funds are required by law to maintain $3 of assets for every $1 borrowed as debt, and $2 for every $1 issued
as preferred shares.
The Dreman/Claymore Dividend & Income Fund redeemed more than $300 million, or 71%, of its auction-rate preferred shares last
year to stay in line with legal requirements.
The Putnam Municipal Opportunities Trust fund had $394 million of leverage through auction-rate preferreds in early 2008, but in
the fall its board announced its merger with an open-end fund to address the high cost of leverage. Since that announcement, the fund
has eliminated leverage of at least $116 million.
Write to Shefali Anand at shefali.anand@wsj.com
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