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Portfolio > Mutual Funds > Bond Funds

Warning: Don't chase returns with exotic products

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Interest rates are at historically low levels. That means many of your senior clients, who typically live on a fixed income, may be hurting. What better time than right now to warn them of the dangers of risky and complex products promising higher returns.

To that end, the Financial Industry Regulatory Authority (FINRA) has issued an Investor Alert cautioning them about putting assets into products such as structured notes with principal protection, high-yield bonds, floating-rate loan funds and leveraged products.

FINRA’s Investor Alert, “The Grass Isn’t Always Greener–Chasing Return in a Challenging Investment Environment,” was prompted by significant recent inflows into investments like high-yield bond funds, floating-rate loan funds and structured retail products. High-yield bond funds had $75 billion in new sales in 2010. Floating-rate funds grew from $15 billion in 2008 to $60 billion in April, and sales of structured products increased from $33 billion in 2009 to $54 billion in 2010.

Look beyond the yield
“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,” said Gerri Walsh, FINRA’s vice president for investor education.

FINRA is concerned about the number of investors that are turning to higher-risk products such as:

  • High-yield bonds, characterized by lower credit ratings, higher risk of default and consequently a more attractive interest rate to compensate the investor for the additional risk.
  • Floating-rate loan funds, which invest in loans extended by financial institutions to entities of below investment-grade credit quality. Such companies usually have a high debt-to-equity ratio, and the loan yields tend to be higher than investment-grade bonds.
  • Structured retail products, which involve unsecured debt with payoffs linked to a variety of underlying assets. They have significant drawbacks such as credit risk, market risk, lack of liquidity and high hidden costs.
  • Leveraged products, including ETFs and mutual funds that seek to deliver multiples of a specified benchmark by increasing exposure to the benchmark through the use of derivatives.


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