High-yield bond funds lost an average of 26% in 2008, but the range of the performance was astounding, Andrew “Buddy” Donohue, director of the SEC division of investment management noted in a speech Thursday before the Practising Law Institute—ranging a full 85 percentage points between 7% for the best-performing fund to negative 78% for the worst-performing. And ranges proved to be incredibly wide for all asset classes, with 70% of actively managed funds underperforming their benchmarks in 2008, Donohue noted.

Given the wide disparity in performance that mutual funds delivered in 2008, and the industry’s duty to encourage investors not to rely on short-term but long-term performance, Donohue reasoned, funds should not be overleveraged. Nor, perhaps, should they use complex hedging. “Not all innovation or ingenuity is positive,” Donohue said.

But because of their exposure to structured investment vehicles, Treasuries and commercial paper at a time when credit markets have seized up, fund companies have had to prop up their money market funds to prevent them from breaking the buck.

Providing liquidity and stability are “twin goals [that] at times can conflict,” Donohue noted. “In times of severe market turmoil, the twin goals may not be able to be achieved simultaneously,” Donohue said.

While the $1 net asset value has added to money market funds’ popularity, Donohue conceded, a $10 or floating NAV can make the funds less sensitive to volatility and better represent the funds’ true value.

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