The Financial Industry Regulatory Authority (FINRA) has finally joined the crowd in warning investors about the risks of bonds and bond funds in the current environment. If FINRA is worried about bonds, the end may be near. FINRA may be late in warning investors about bond and bond fund risks say financial advisers, but investors should pay attention (“Finra bond warning a real worrier,” InvestmentNews).
FINRA issued an investor valentine last Thursday (Feb. 14) warning that when interest rates rise, “outstanding bonds, particularly those with a low interest rate and high duration, may experience significant price drops.” Superstar investors Bill Gross (co-founder of the world’s largest bond fund) and Jim Rogers (former partner of George Soros), as well as Goldman Sachs, among others, have been sounding the alarm on bond risk for some time.
Interest rates rose slightly last month. That may or may not signal the start of a major rise. The Federal Reserve has promised to keep interest rates low until the unemployment rate hits their target, but ultimately the market, which has a mind and emotion of its own, will set interest rates by deciding how much it is willing to pay for low-interest rate bonds.
FINRA’s message is basically that investors should not believe that bonds and bond funds are relatively safe. According to FINRA, a bond fund with a 10-year duration will decrease in value by 10% if rates rise 1 percentage point. FINRA urged bond investors to pay attention to duration, since the longer the duration, the greater the sensitivity to interest rate changes.
FINRA also noted that even short-duration bonds are subject to inflation risk, call risk, and default risk. In addition, some bond funds contain holdings that are more complex and hard to evaluate than traditional bonds, and are often categorized as “other” holdings in federal filings.
Page Perry is an Atlanta-based law firm with over 150 years of collective experience maintaining integrity in the investment markets and protecting investor rights.