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Subprime woes may hit funds

WASHINGTON - Could the housing market's woes spread to bonds held in mutual funds by millions of ordinary investors?

Some funds that invest in riskier short-term debt already have been whacked by soaring default rates on bonds backed by mortgages given to borrowers with weak credit.

Huge losses "won't be the norm" for most mutual funds, predicts Paul Herbert, a senior mutual fund analyst with research firm Morningstar Inc. However, he does expect losses in investment-grade rated bonds backed by the worst-performing mortgages.

Morningstar, in a report published last month, identified several mutual funds that have invested in short-term bonds - including subprime debt - that have suffered losses this year.

Fidelity Advisor Ultra Short Bond A and Fidelity Ultrashort Bond, managed by Fidelity Investments, have both lost almost 5 percent of their value for the year, a sharp drop for a fixed-income fund.

The declines were caused by several factors, including the funds' "holdings in subprime mortgage securities, which have primarily been in the highest-rated AAA and AA" [segments of debt] and exposure to deteriorating conditions in the bond market generally, Sophie Launay, spokeswoman for Boston-based Fidelity, said in an e-mail.

The rating agencies "missed the boat," said Janet Tavakoli, president of Tavakoli Structured Finance, a Chicago consulting firm.

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