- Yield Chasing Investors Are Buying Riskier Credits
- Sales of Junk Rated Bonds and Risky Structured Products Are Booming
- Retail Investors Could Get Burned By High Yield Credits
With the Federal Reserve cutting interest rates, investors and savers have gotten carried away with tantalizing yields on riskier products.
Indeed, investors are buying “hundreds of millions of dollars of debt issued from unrated or below investment grade borrowers such as energy projects and upstart charter schools,” according to a recent report in the Wall Street Journal.
That is alarming.
According to the Journal, the sale of risker new municipal bonds, combined with “the deterioration of some existing debt” has increased the amount of outstanding junk-rated and unrated debt by 20% since 2012.
The problems in the new junk bond issues range from borrowers that outright default to those that tap cash reserves to make payments, according to the Journal.
“Bonds such as these aren’t backed by a promise to raise taxes if necessary, as is often the case with cities and states seeking funds,” the Journal notes. “As a result, they typically offer additional yield to compensate for that risk – income that has proved tantalizing for investors after years of rock-bottom rates.”
Another Journal article reported that yield chasing investors added $13.5 Billion dollars to bond portfolios in August after dumping their stock funds.
That article reported that Wells Fargo Asset Management is recommending that clients increase allocation to BBB-rated and BB corporate bonds while reducing holdings in the stock market. These ratings represent the lowest-rated part of the investment-grade credit spectrum and the highest part of the speculative-grade or junk market.
For years, regulators have cautioned that the complex products may be hard for a retail investor to evaluate and could be misleadingly marketed as conservative fixed-income investments. For example, in 2016 the SEC charged UBS Financial Services for unsuitable sales of $548 million of reverse convertibles to 8,700 inexperienced investors.
Despite these warnings, the volume of complex, structured products distributed to U.S. retail and high-net-worth individuals in 2018 increased to just over $48 billion, according to an industry survey.
Who are the biggest suppliers of the product? Why, just some of the biggest names on Wall Street: HSBC, J.P. Morgan, Barclays, Goldman Sachs, Credit Suisse and Morgan Stanley.
Unfortunately, these products are popular for the same reasons many financial products are popular—either they carry large commissions for the sellers or big fees for the product maker.
Thus, unscrupulous brokers and financial advisers push these risky products whilst assuring Mom and Pop clients that they are safe and secure.
Without a doubt, savers and bond investors are understandably concerned about the low return of their portfolios. But they need to be aware that when they invest in products touting higher yields, like this new version of muni bonds and the proliferation of structured products, they are also buying higher risk.
We have seen highly rated bonds in Puerto Rico go into default, leaving many investors holding the bag. Other junk-rated corporate bonds like General Motors have also gone into bankruptcy, resulting in substantial investor losses.
Investors need to beware before jumping into the deep end of Wall Street’s latest “yield pool.”