Investors Should Proceed With Caution in Investments That Promise ‘Bond-like’ Features

As investors grow increasingly leery of bonds and the potential increase in interest rates, many are turning to alternative investment products that promise big yields and preservation of capital. However, many of these bond-like funds are far from the bond-like products they promise to be.

An April 21 story by Investment News highlights the confusion for both advisers and investors when investing in bond-like funds. The story cites the example of broker/dealer Securities America and its marketing of notes issued by Medical Capital Holdings to advisers as, “the missing piece that should be included in your fixed-income arsenal.”

In reality, Medical Capital turned out to be a $2-plus billion Ponzi scheme and was charged with fraud by the Securities and Exchange Commission (SEC) in July 2009.

Unfortunately, Securities America clients invested about $700 million in the investment scheme.

Earlier this year, the Financial Industry Regulatory Authority (FINRA) fined two broker/dealers affiliated with The Hartford Financial Services Group $100,000 for promoting a mutual fund that made “unwarranted” and “misleading” statements in light of changing conditions to the bank loan market in 2008 and 2009. The fund, Hartford Floating Rate Fund, has $6.5 billion in assets.

“In particular, the brochure contained misleading statements that the mutual fund was appropriate for bond investors concerned about the price stability of their investments, provided the potential for greater price stability compared with other fixed-income investments and was appropriate for investors seeking some degree of capital preservation,” said FINRA in its April listing of disciplinary actions. “Given the conditions in the bank loan market during the relevant period, these statements were not accurate.”

Another investment product on FINRA’s radar is leveraged-loan funds. Leveraged-loan funds are often touted as less sensitive to interest rate movements but carry heavy risks, says FINRA.

The bottom line: Before investing in financial products that tout bond-like features, investors are wise to thoroughly understand the credit quality and risks of those investments.