Coronavirus (COVID-19) Crisis: Receding Financial Markets Have Exposed Many Portfolio Allocations as Inappropriate and Unsuitable

Coronavirus (COVID-19) Crisis:  Receding Financial Markets Have Exposed Many Portfolio Allocations as Inappropriate and Unsuitable (especially where high-yield investments such as high-yield bonds, junk bonds, real estate investment trusts (REITs), and master limited partnerships (MLPs) were recommended to seniors and retirees)

Famed investor Warren Buffett once stated, “It’s only when the tide goes out that you learn who’s been swimming naked.”  The impact of the coronavirus crisis on the financial markets is now demonstrating this point emphatically. 

Recent Losses in High-Yield (or Junk Bond) Investments
As we discussed previously here and here, high yields on investments frequently mean high risk.  These high risks can remain invisible in stable bull markets, such as the markets we experienced from 2009-2019.  However, when disruptive economic forces emerge, the risks surface and high-yield investments predictably find themselves in a tailspin.  Put differently, the receding market values expose the previously hidden risks in a portfolio. This is now more true in the current time than ever.  Indeed, there are multiple reports about how record levels of corporate debthave set up high-yield bonds (including high-yield bond mutual funds and exchange traded funds (ETFs)) for exceptional disaster. 

These concerns of high yields are not limited to junk bonds, either.  It has been widely reported that, in recent years, investment grade bonds of the lowest tier (BBB) have come to make up a disproportionate amount of available investment grade bonds. When the rating of a given bond is downgraded from BBB to BB, that bond is deemed to no longer be of “investment grade” quality and it is reclassified as a “junk bond.”  While BBB-rated bonds are technically “investment grade,” their “on the edge” investment grade ratings make them aptly referred to as “near-junk” bonds and give them many of the same risks of junk bonds.  In the current environment, there is a substantial probability that persons holding allegedly “investment grade” bonds will find those bonds performing more like the near-junk bonds they are. Indeed, many such BBB-rated bonds stand to be downgraded to BB, or junk status—which, in turn, will cause the bond’s principal value to decline.  

Recent Losses in REITs and MLPs Have Exposed Their High Risks, Too 

The coronavirus crisis has also specially impacted other categories of securities that financial advisors often recommend to fixed-income oriented clients due to their high-yield characteristics.  Two often recommended categories are Master Limited Partnerships (MLPs), such as those in the energy sector, and Real Estate Investment Trusts (REITs), such as those which hold huge positions in commercial real estate.  The impact of the coronavirus pandemic has put pressure on oil prices and driven down commercial real estate values tremendously, exposing the major risks and sensitivities laden in these investments.  As one example, the per-share price of the REIT known as “Simon Properties Group” (ticker symbol SPG) declined in just weeks in early 2020 (as the pandemic became widespread and the focus of our country) from $149 to $43, a devastating loss for shareholders of 71%.    

The High Risks of These Investments Were Likely Often Omitted by Financial Advisors 

FINRA rules and state and federal laws mandate that financial advisors have a duty to make only suitable recommendations.  In recent years, we have seen many occasions in our case work where financial advisors have breached this duty by recommending high-yield (i.e., high-risk) investments to seniors and retirees—often in the form of “high-yield” bond funds, REITs, and MLPs.  Instead of recommending safe high-grade fixed-income investments, such as AAA-rate corporate bonds and government issued Treasury bills (many of which did not experience substantial decline in March 2020 when the markets dropped sharply), unscrupulous financial advisors may have found it easier in recent years to pitch clients on bond funds and REITs with annual yields of 5% or more per year even when those clients wanted low-risk investments, such as government bonds.  But, all too often, financial advisors who make unsuitable recommendations like this often do so by misrepresenting or omitting the actual risks of the recommended investments, instead focusing the client’s attention on the annual yield.

In March 2020, this practice of omitting material risks from unsuspecting clients left many investors with massive losses, or, as Warren Buffet said, it demonstrated “who’s been swimming naked.”  Take, for example, the largest junk bond ETF, the iShares High Yield Corporate Bond ETF (ticker symbol: HYG).  Over the one-month period ending March 23, 2020, HYG declined by 23.1%.  Near the beginning of HYG’s prospectus it states, “you could lose all or part of your investment in the Fund.”  Other specific risks (or which there are many) are discussed as well.  Had those risks been disclosed by financial advisors to clients prior to purchase years before, many clients would have refused to authorize the purchase of HYG.  This, in turn, would have naturally resulted in the selection of much safer bonds for those same clients.  And, safe bonds (such as United States government bills and bonds) actually appreciated in price during the first quarter of 2020.  All financial advisors know that shopping for higher yield means shopping for higher risk—but we have found that all too-often, this basic fact is not communicated by financial advisors to unsuspecting clients when recommendations are made.        

The failure of financial advisors to recommend suitable investments, and to disclose all material risks, can be actionable securities fraud and a breach of fiduciary duty.  In fact, FINRA Rule 2210 requires brokers and financial advisors to make only fair and balanced sales presentations to clients, which includes giving ample treatment to the risks inherent in purchasing and owning a given investment.  The law mandates that clients be provided with the information needed to make an informed decision.  By omitting material risks—such as “you could lose all or part of your investment” (see HYG prospectus)—from unsuspecting clients, financial advisors breach their duties and violate applicable rules and laws.  

The Law Offices of Montgomery G. Griffin, based in Newport Beach, California, has always centered its practice on assisting harmed investors in obtaining recoveries against brokers, financial advisors, and brokerage firms in cases of financial advisor misconduct.  If you believe that a high-yield investment may have been inappropriately recommended to (or purchased for) you, or that other inappropriate investment advice or management was given to you, you can contact the Law Offices of Montgomery G. Griffin using the form below for a free legal consultation.  Among many other high-yield investments investors may have been placed into are the following investments:

  • iShares High Yield Corporate Bonds (HYG)
  • SPDR Barclays Capital High Yield Bond ETF (JNK)
  • iShares Broad USD High Yield Corporate Bond ETF (USHY) 
  • Simon Property Group (SPG)
  • Tanger Factory Outlet Centers Inc. (SKT)
  • Prologis Inc. (PLD)
  • Macerich Co (MAC)
  • Energy Transfer LP (ET)
  • Enterprise Products Partners LP (EPD)
  • Brookfield Property Partners LP (BPY)