Dangers in Higher Yields

Bloomberg BusinessWeek has published a story about some of the extreme derivative products being sold to retail investors looking for a higher yield.  This fast-growing business involves highly complicated products that several experts warn most investors don’t really understand.

While reading this I was reminded of Mel Lindauer’s concerns that too many investors are wandering into exotic regions to juice the return on their income investments. Clearly these particular products are in high demand. According to the piece, $31.9 billion worth of structured notes were sold in the first eight months of 2010, up 58% from the same period last year.

The products carry high margins for the banks selling them, but can be mind boggling in their complexity and their uncertainty of  outcome.

Bloomberg reporter Zeke Faux describes one:

Morgan Stanley’s CMS Curve securities offer a fixed 10 percent rate for two years. The yield for the next 13 years is five times the difference between long- and short-term constant maturity swap rates, not to exceed 18 percent annually, earned when the Standard & Poor’s 500-stock index doesn’t dip below 875, according to a regulatory filing.

Not your Dad’s T-bill that’s for sure.

Back in late 2006, the Securities Litigation and Consulting Group, concluded structured products are “virtually never suitable for unsophisticated investors.”

Because they:

  • Are difficult to evaluate and monitor
  • Involve Hidden Costs
  • Are illiquid.

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