PaineWebber to Prop Up Mutual Fund Damaged by Derivative Trades

PaineWebber Group Inc. said Friday that it will spend $180 million to prop up an ailing mutual fund that had tumbled in value due to losses in risky derivative securities.

The action--part of what is believed to be the largest-ever bailout of a mutual fund--is one of the starkest examples of how the tumbling market for those exotic securities has hammered brokerages and banking firms this year. BankAmerica Corp., for example, had to inject money to prop up a fund hurt by losses from derivatives.

PaineWebber said it will prop up the ailing Short-Term U.S. Government Income Fund by buying some of the fund’s weakest securities.

The brokerage’s cash buyback of fund securities is equal to nearly a quarter of the fund’s value.

That injection raises to $286 million the amount PaineWebber has spent to bail out the fund. The latest $180 million comes on top of injections in early June of $33 million in cash and a purchase of $55 million of the fund’s mortgage-backed derivatives, which are securities based on, or derived from, homeowners’ monthly mortgage payments.

The June cash infusion was responsible for the firm’s second-quarter loss of $25 million, or 35 cents a share.

That contrasts with a profit of $59.3 million, or 74 cents a share, in the 1993 quarter.

PaineWebber stock closed unchanged at $16.375 in trading Friday on the New York Stock Exchange.

Newport Beach-based Pacific Investment Management Co., a major bond investment manager, has agreed to act as a consultant with the fund’s portfolio.

Market demand, or liquidity, for mortgage-backed securities began drying up in early February after the Federal Reserve Board pushed interest rates higher for the first time in five years.

Shareholders in the PaineWebber fund lost 7.15% of their investment through the first six months of this year, according to the Chicago-based Morningstar Mutual Funds report.

The drop is significant among short-term bond funds, which generally are considered extremely safe and able to retain their value even in times of market declines.

“A lot of people might buy a fund with ‘government’ in the name and might automatically think it’s safe,” said Jeff Kelley, an associate editor of the Morningstar report.