Are you reaching for yield? This article in Bloomberg Businessweek illustrates the perils of reaching for yield in reverse convertibles. If the yield looks too good to be true, it probably is.
A Stock-Bond Hybrid That Flopped By Zeke Faux, Business Week
“Reverse convertibles, which are marketed to individuals by some of the country’s largest brokerages, are typically short-term bonds that convert into stock if a company’s share price plummets. In effect, an investor who buys a reverse convertible is actually selling a put option—the right to sell a company’s stock at a certain price. Investors also take on credit risk because the notes are unsecured debt.
Sound complicated? That’s part of the problem. Individuals attracted by the high interest rate may not understand how the notes work, says Marilyn Cohen, who oversees $325 million as chief executive officer of Envision Capital Management in Los Angeles.
“This isn’t something that a retail investor calls up and asks for,” she says. “Is it ever explained … that you might end up with the stock and there’s a large probability that will happen?”
It did happen to Leroy and Carol Conklin, a retired couple in Sun City Center, Fla., who say they were told about reverse convertibles by James Tuberosa, a broker at H&R Block Financial Advisors whom they met at their retirement community’s annual FunFest fair. They bought some from Tuberosa in 2007 and 2008, they say, including $20,000 of notes linked to home improvement retailer Lowe’s that paid 9 percent and that the broker called corporate bonds. “I said, ‘Boy, this is a good investment,’ ” says Leroy Conklin, 80.
After a drop in Lowe’s share price, the Lowe’s notes converted into stock worth $4,000 less than the Conklins had paid for them, says Jason Doss, the Conklins’ lawyer. He puts the Conklins’ total loss on all the reverse convertibles they bought at about $130,000. The Conklins filed an arbitration claim against Ameriprise Financial, which bought H&R Block’s financial advisory business in 2008. A hearing is scheduled for May. Tuberosa, who works for Ameriprise in Sun City Center, declined to comment, as did Benjamin Pratt, an Ameriprise spokesman.”
Jeremy Jones, CFA
Latest posts by Jeremy Jones, CFA (see all)
- How Will the World Handle Such Unprecedented Central Bank Balance Sheets? - August 16, 2017
- Is Active Management Finally Set to Outperform? - August 15, 2017
- Bond Market Warning Signs - August 14, 2017