Two years ago, in the summer of 2011, FINRA released its investor alert "The Grass Isn’t Always Greener—Chasing Return in a Challenging Investment Environment."1 The alert focused on how investors, in the then-existing low interest rate environment, were purchasing structured products and other more complex investments in an effort to increase their returns.
What has changed in the past two years?
The rate environment hasn’t necessarily changed much. (See graph below.) But product offerings have evolved, and some of them raise issues that make the investor alert still relevant today.
The 2011 alert was issued not long after several FINRA actions involving unsuitable sales of "reverse convertible securities." Since that time, many broker-dealers have enhanced their supervision of sales of that particular product, and the investing public has developed a greater awareness of how it works, and for whom it is designed. (And we also believe that the disclosure documents relating to these products remain robust, with prominent disclosure of the key risks.)
The 2011 alert also focused on "curve steepeners," which can be used in some markets to increase yields. However, here in the summer of 2013, the effectiveness of these products is threatened by a narrowing gap between short-term and long-term rates2
Of course, the key retail structured product types that remain from the 2011 alert are non-principal protected notes. And since 2011, product manufacturers have increasingly offered different products that are designed to enhance yield, in a manner that is consistent with an investor’s market outlook and risk tolerance. Various types of conditional coupon notes, autocallable notes, and "non-principal protected" range accrual notes all can be used to enhance returns. But of course, these products may result in losses, or lower returns, under different market scenarios.
These types of products may not have generated the type of specific regulatory focus of "reverse convertible notes." (And again, we believe the terms and risk factors of this class of products are the subject of many very carefully written disclosure documents.) However, brokerages must be careful to ensure that, like any other product, they are recommended only to appropriate investors, who understand their risks. Sales pitches about their above-market coupons need to be carefully balanced with a proper explanation of the downside. Brokerages also will want to know that any distributors to whom they are sold can market them in an appropriate manner.
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