Earlier this month, the SEC and FINRA issued a stern warning to investors around structured products promising principal protection:
While these products often have reassuring names that include some variant of “principal protection,” “capital guarantee,” “absolute return,” “minimum return” or similar terms, they are not risk-free. Any promise to repay some or all of the money you invest will depend on the creditworthiness of the issuer of the note—meaning you could lose all of your money if the issuer of your note goes bankrupt.
Yet, last week during Pershing's INSITE conference in Hollywood, Fla., an entire session was devoted to structured products distributors who gave their spiel. The session talked about how these products are driving growth in the marketplace, with $20 billion in new issuance in 2010 and $25 billion in new issuance projected for this year. Market-linked CDs in particular are gaining in popularity, the panelists said.
What's behind the popularity? Serge Troyanovsky, managing director at BNP Paribas, said the rationale is enhanced income, market participation, portfolio diversification and, of course, principal protection. MLCDs sold by BNP Paribas are FDIC-insured.
I have to give the session some credit for pointing out the risks, although they weren't given the play necessary. Credit Suisse's Elaine Sam said risks include the creditworthiness of the issuer, liquidity, factors that affect second day market value, embedded fees, tax implications and market risk.
That said, these investment vehicles are confusing and opaque. How much do we really understand about them? Before advisors and investors fall head over heels for the promise of principal protection, we ought to think twice about what FINRA and the SEC are saying, lest we step on another landmine we didn't see coming.