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Income Investors In Risky, Energy-Related Products Get Creamed

February 12, 2016 Blog

Brokers who pitched energy based structured products during the recent oil boom to conservative clients will be flooded with phone calls from angry clients.

As the price of oil has crashed from $100 a barrel less than two years ago to below $30 on Thursday, investors who bought structured products looking to generate income have been crushed.

The pain felt by investors in the futures market, energy partnerships, high-yield corporate bonds and the shares of oil and gas companies is well known, noted Wall Street Journal columnist Jason Zweig last weekend.

But the plummeting price of oil is also “wreaking havoc” on opaque and complex structured products tied to the price of oil, Zweig reported.

In 2015, the biggest names on Wall Street, including Bank of America, Morgan Stanley and Goldman Sachs, issued at least 300 so-called “structured notes,” which are short-term borrowings with returns linked to the price of oil or other energy-related assets.

Remember those heady days, just a year ago? It was a perfect time for Wall Street to pump out high risk products and sell them to Mom and Pop investors. The stock market had gone up in almost a straight line since March 2009, the depths of the credit crisis. The demand for commodities seemed vast, and the U.S. energy industry, with the boom in fracking, looked invincible even though oil prices had started to slide.

Those structured securities issued last year total at least $1.3 billion, with most maturing later this year. Investors have a bit of time for oil to bounce back, however, if that bounce doesn’t happen, expect a flood of investor complaints to be filed against the brokers and broker-dealers who sold the structured notes.

The allure of the notes and structured products is that investors can make a lot of money if oil goes up just a smidge, with some notes tripling gains at a capped rate. But in some cases there is no protection on the downside, so investors will see “dollar for dollar losses, without limit,” if the fund goes down, noted Zweig.

But getting back to even will not be easy, noted one analyst cited by Zweig.

“They vast majority of them are underwater,” said the analyst. “And a lot are materially underwater. On many of them, you’d need a 50% to 100% jump in the price of oil from today’s levels to get to break-even.”

“This is not really an investment strategy so much as a wager on which way oil prices are going,” another analyst told Zweig. “And some of the risks and costs of that wager are masked by the complexity of it.”

Hidden risks and costs, a complicated investment structure based on derivatives – readers, these are red flags in any market.

“Many people who thought they were buying black gold on the cheap appear to own a black hole instead, with limited means of escape,” concludes Zweig.

We couldn’t agree more.

Zamansky LLC are securities and investment fraud attorneys representing investors in federal and state litigation against financial institutions.