Will the bond bubble burst?

Thursday, June 13th, 2013

When disclosing the risk of a particular bond offering, a financial advisor must make the investor fully aware of the following risks associated with all bonds: (1) Inflationary risk – i.e., the risk that fixed-income investments historically underperform other investments during times of inflation; (2) Credit risk – i.e., the risk that the company offering the bond could be downgraded by reporting agencies (such as Moody’s) affecting the value of the bond, and (3) Interest rate risk – i.e., the risk that the value of the bond could decrease if interest rates increase (this is precisely the risk that is currently present in the bond market and which must be disclosed by a broker before recommending a bond to any client).

In today’s investment climate, the big disclosure that a broker must make has to do with interest rate risk.  With interest rates at all time lows, history tells us that the risk that current long term bonds will reduce in value when/if rates increase is quite high.  If a financial advisor failed to disclose this potential risk of investing in bonds, and instead represented that investing in bonds is “safe,” then the investor may have a claim for failure to adequately disclose the true risks of investing in bonds at historically low yields.  This risk is magnified if the maturity of the bond is longer.  The longer the maturity of a particular bond or group of bonds, the greater impact changing interest rates will have.  So, if a financial advisor recommends to a client in a historically low yield environment (like the one we are currently in) to over-concentrate their portfolio in long term bonds, the risk of loss is substantially greater than if the broker recommended short term bonds.

With various experts predicting that an increase in interest rates could result in dramatic losses in long term bonds, the question becomes which funds are potentially at risk.  The following are all bond funds with long “effective maturities”:

BlackRock High Yield Municipal Instl
BlackRock High Yield Municipal Inv A
BlackRock High Yield Municipal Inv C
Federated US Government Bond Svc
Franklin AL Tax-Free Income A
Franklin AL Tax-Free Income C
Franklin CA Insured Tax-Free Inc A
Franklin CA Insured Tax-Free Inc Adv
Franklin CA Insured Tax-Free Inc C
Franklin CA Tax-Free Inc Adv
Franklin CA Tax-Free Income A
Franklin CA Tax-Free Income B
Franklin CA Tax-Free Income C
Franklin CO Tax-Free Income A
Franklin CO Tax-Free Income Adv
Franklin CO Tax-Free Income C
Franklin CT Tax-Free Income A
Franklin CT Tax-Free Income Adv
Franklin CT Tax-Free Income C
Franklin Double Tax-Free Income A
Franklin Double Tax-Free Income Adv
Franklin Double Tax-Free Income C
Franklin Federal Tax-Free Income A
Franklin Federal Tax-Free Income Adv
Franklin Federal Tax-Free Income B
Franklin Federal Tax-Free Income C
Franklin FL Tax-Free Income A
Franklin FL Tax-Free Income C
Franklin High Yield Tax-Free Inc A
Franklin High Yield Tax-Free Inc Adv
Franklin High Yield Tax-Free Inc B
Franklin High Yield Tax-Free Inc C
Franklin Insured Tax-Free Income A
Franklin Insured Tax-Free Income Adv
Franklin Insured Tax-Free Income B
Franklin Insured Tax-Free Income C
Franklin MA Tax-Free Income A
Franklin MA Tax-Free Income C
Franklin MD Tax-Free Income A
Franklin MD Tax-Free Income Adv
Franklin MD Tax-Free Income C
Franklin NC Tax-Free Income A
Franklin NC Tax-Free Income Adv
Franklin NC Tax-Free Income C
Franklin NY Tax-Free Income A
Franklin NY Tax-Free Income Adv
Franklin NY Tax-Free Income B
Franklin NY Tax-Free Income C
Franklin PA Tax-Free Income A
Franklin PA Tax-Free Income Adv
Franklin PA Tax-Free Income B
Franklin PA Tax-Free Income C
Franklin VA Tax-Free Income A
Franklin VA Tax-Free Income Adv
Franklin VA Tax-Free Income C
Guggenheim Municipal Income A
Guggenheim Municipal Income C
Guggenheim Municipal Income Instl
Ivy Municipal High Income A
Ivy Municipal High Income B
Ivy Municipal High Income C
Ivy Municipal High Income I
Ivy Municipal High Income Y
Pioneer High Income Municipal A
Pioneer High Income Municipal C
Pioneer High Income Municipal Y
RS High Income Municipal Bond A
RS High Income Municipal Bond C
RS High Income Municipal Bond Y
T. Rowe Price Tax-Free High Yield
T. Rowe Price Tax-Free High Yield Adv
T. Rowe Price US Treasury Long-Term
Vanguard Extended Dur Treas Idx I
Vanguard Long-Term Bond Idx InstlPls
Vanguard Long-Term Bond Index I
Vanguard Long-Term Bond Index Inv
Vanguard Long-Term Corp Bond Idx I
Vanguard Long-Term Corp Bond Idx Signal
Vanguard Long-Term Govt Bd Idx Signal
Vanguard Long-Term Govt Bond Idx I
Vanguard Long-Term Treasury Admiral
Vanguard Long-Term Treasury Inv
Waddell & Reed Muni Hi-Inc A
Waddell & Reed Muni Hi-Inc B
Waddell & Reed Muni Hi-Inc C

Due to their long maturities, these bond funds appear most exposed to the risk of increased interest rates.

If you suffered losses investing in long-duration bond funds and would like to discuss your litigation options, please call the securities attorneys of The White Law Group at 312/238-9650 for a free consultation.

The White Law Group is a national securities fraud, securities arbitration, and investor protection law firm with offices in Chicago, Illinois and Boca Raton, Florida.

For more information on The White Law Group, visit http://www.whitesecuritieslaw.com.

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