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Ultra short-term bond funds have been collapsing since early July 2007, and the carnage is going from bad to worse. Apparently investors in these funds - billed as slightly higher risk alternatives to money market funds - are liquidating in droves:

Schwab YieldPlus has fallen almost 20% since late January 2008 - four times more than the Nasdaq drop during the same period - which is particularly troubling because the upside of the fund was slim - perhaps 1% more than an investor would get in a traditional low-fee money market fund. As Schwab's website notes, "the fund’s objective is to seek high current income with minimal changes in share price. " This is the type of fund an investor might park some cash they need in a few months to pay for college tuition or to buy a house - or just to avoid the risk of the stock market or even longer-term bond funds.

Ultra short-term bond funds' trouble started last year. The adjustable rate mortgage and corporate debt these funds invested in was far riskier than the investment grade ratings would lead one to believe. The current trouble has as much to do with the open-end fund structure itself as with continuing home-loan and other adjustable debt mark downs: when investors panic sell all at once the fund manager has no choice but to sell portfolio holdings at the same time to raise cash - often at lower prices than the fund thought the holdings were worth.

Sudden increased selling by fund shareholders leads to lower security prices of the fund holdings which drives the fund price or NAV down even more, which in turn leads to more fund investors selling. As many of these types of funds have "Free, unlimited checkwriting" and all have no redemption fees, there is nothing standing in the way of nervous shareholders getting out. Selling at large funds like Schwab YieldPlus can drive prices down for other funds that own the same or similar securities as well. Mutual funds in such a death spiral will not come back to their original price even if the hard hit portfolio holdings rebound in price.

See also:

Why You Should Worry About Your Bond Funds
Is Your Bond Fund a Ticking Sub-Prime Time Bomb?

Which stock funds are best? Which fund categories are most attractive? The MAXfunds Our Favorite Funds Report answers these and other key questions facing fund investors. Fortunately for you, dear fund investor, Our Favorite Funds is now available for FREE. And unlike most things, you get more than you pay for.

With thousands of mutual funds and dozens of fund categories to choose from, selecting the right funds is tough enough, but building a well balanced portfolio is becoming more difficult by the day. Our Favorite Funds is our handpicked list of the best mutual funds in each fund category, along with our analysis of each fund category as a whole.

Discover the complete list of MAX's Favorite Funds by clicking here.

Forbes just published its list of 'Honor Roll' funds for 2007, and while there's not a real stinker in the bunch – this is no buy list. Here are the funds that made the cut, along with our MAXrating for each one:

Bruce Fund (BRUFX) MAXrating: 84
Delafield Fund (DEFIX) MAXrating: 63
Keeley Small Cap Value (KSCVX) MAXrating: 68
Mairs & Power Growth Fund (MPGFX) MAXrating: 80
Muhlenkamp Fund (MUHLX) MAXrating: 61
Osterweis Fund (OSTFX) MAXrating: 77
Perritt MicroCap Opportunities (PRCGX) MAXrating: 93
Stratton Small-Cap Value (STSCX) MAXrating: 70
Third Avenue Value (TAVFX) MAXrating: 85
Value Line Emerging Opportunities (VLEOX) MAXrating: 93

According to Forbes, to get on the Honor Roll "contenders must pass a number of stringent tests. The managers must have been on the job for at least six years; a newbie can't ride on the boffo showing of his predecessor. We also want portfolio diversification. Thus sector funds don't get in. And a fund must be open to new investors." Forbes also looks at how well funds have done through past up and down markets.

But like all top fund lists, this one has its share of problems... ...read the rest of this article»