FINRA issued a warning to investors yesterday to about the risks of seeking higher yield with structured products, junk bonds and floating-rate bank-loan funds. It is a reality of New York securities law that with fixed income yields at historic lows, many investors who want to avoid the volatility of the stock market have found themselves with seemingly nowhere to go.
Many of these investors have found themselves lured in by structured products promising of higher yield with “principal protection” or junk bond funds promising higher yield with “professional management”. FINRA reports that there have been significant increases in sales of high-yield bond funds, floating rate funds and structured products. These products have seen more than $100 billion in increased sales since interest rates fell.
However, average investors often don’t look into or have trouble understanding the risks and fees associated with these investments. Investors typically only focus on the higher returns that these investments offer but should also be aware that these products typically have higher risks and fees associated with them.
Many of these risks and fees may not be readily apparent to the average investor, but are key to making a fully-informed decision about investing. Gerri Walsh, FINRA’s vice president for investor education said, “Investors should never make an investing decision solely by looking at an investment’s return, whether past or projected. Higher returns come with higher risk. Investors should always look behind an investment’s yield, ensure that they understand how the investment works and carefully consider its fees and risks before investing,”
Floating-rate bank-loan funds may appear to be less vulnerable to interest rate fluctuations and offer inflation protection. However, many of the underlying loans may be sub-investment grade quality and can be subject to significant credit, valuation and liquidity risk.
Structured retail products may make investors feel safe since they appear to be “guaranteed” or “principal protected”. However, investors often do not realize that these products are typically unsecured debt that is linked to a series of underlying assets. These products can be subject to market risk, credit risk and lack liquidity and may also contain high hidden costs.
Junk bonds are bonds that are rated as being below investment grade, meaning they have a higher risk of default than investment grade bonds, which is why these products have higher yields.
Leveraged products also promise higher returns than their target index, but investors often don’t realize that this is only possible through the use of complex derivatives, which oftentimes will also compound losses when the target index fails to perform as hoped.
It is important that before you make an investment to understand the product you are investing in.
Many financial professionals will often accentuate the positives without fully disclosing the potential risks of an investment. Investors should not be embarrassed to admit that they do not understand the complexities of the product or be afraid to question their financial professional about how the investment works and what are the potential risks if the investment goes bad. Only then can you make a fully-informed decision about where you invest your savings.
Malecki Law handles all types of Security law matters, including fraud allegations, unsuitability claims, audits and investigations, and whistleblower cases. If you believe that you were recommended unsuitable investments, call 212-943-1233.