Butterfield performance bond

The announcement that Butterfield Asset Management has frozen its Liquid Reserve Fund is definitely not a good sign.  To put this into context, the 'liquid' fund is one step above Butterfield's money market fund and is considered the kind of place to store your cash when the market is too risky to invest in, but is supposed to be as readily accessable as cash.  The fact that Butterfield has frozen its liquid fund is a rather scary turn of events when you consider that the Bermuda Government has effectively provided Butterfield with a $400 million performance bond (a $200 million guarantee @ 8% annually over 10 years)

Butterfield's liquid fund collapsed because it didn't ensure that what it was investing in followed its objectives.  As we noted back when we condemned the 'bailout', businesses and investors have the obligation of performing their own due dilligence when they invest in something.  Ideally, the Bermuda Government should have setup our own form of Federal Deposit Insurance Company to protect those who simply were saving their money as in a worst case scenario, not provided guarantees for Butterfield.  The consiquences now are that if Butterfield goes bankrupt, not only does the taxpayer get hurt, so do those who kept their savings at Butterfield.  Those who bought the preferred shares win but might severely damage Bermuda's credit rating as a result.

Anyway, reviewing the investment objectives of the Liquid Reserve Fund raises serious questions as to the due dilligence undertaken by Butterfield Asset Management's investment team.

Investment Process

Emphasis is on a portfolio of short dated, high quality fixed and
floating rate note instruments.

High quality fixed and floating rate note instruments?  Let's rereview the Royal Gazette article to find out what they invested in.  

According to a Standard and Poor's ratings report from February 2009, the fund invests mainly in corporate floating and fixed-rate securities, as well as asset-backed securities (ABS), mortgage-backed securities (MBS) and a collateralised debt obligation (CDO).

In all fairness the rating agencies share a considerable portion of the blame as they rated many of these instruments far too highly.  However, the expectation is that an investment manager would perform the due dilligence necessary to figure out the proper value of what they're investing in on behalf of their clients rather than simply taking the rating agency's word for it.  By not having done so, they invested in worthless paper in a fund that should have restricted itself to high quality reliable federal and corporate bonds only.

Overall this news is very disconcerting.  The fact that Butterfield has found it necessary to freeze its liquid fund is a very concerning development.  This suggests people are now unable to access that money and suggests that Butterfield does not have the capital to keep the fund liquid enough for people to redeem what is left of their investments.  One can hope that this is the only element of their portfolio and balance sheet that was in need of extra capital and that the recent preferred share offering will provide the funding to right this situation.  However, it is entirely possible that if Butterfield exposed their lower risk liquid funds to these faulty investment instruments that they also exposed significant portions of the rest of their portfolios.  Eventually time shall tell.  What we can hope however is that the Bermuda Government didn't make the same mistake as the BIU by guaranteeing something that they did not ensure would live up to the obligation.