Reverse Convertible Nest-Egg Slashers

Reverse convertible bonds are highly complex and highly speculative investments. Notwithstanding a typical investor’s lack of sophistication, even experienced investors do not commonly know what they are buying when they purchase a reverse convertible bond. For this reason, reverse convertible bonds are also referred to as “Nest Egg Slashers,” a term first coined in the Wall Street Journal when referencing this high-risk investment.

When an investor purchases a reverse convertible bond, the investor is essentially giving an unsecured loan to a financial institution while at the same time writing an out-of-the-money put option on a corporate individual stock. Reverse convertible bonds are often described as short-term, unsecured bonds issued by banks and/or highly-leveraged financial institutions. Typically, they are linked to the performance of a stock and pay higher yields than the average fixed income investment. Once the bonds mature, the investor is supposed to get his or her full principal back; however, if the value of the underlying stock falls below a specific level, called the ”knock-in” level, then the shares get converted into shares of the devalued stock, which the investor receives in lieu of his or her initial investment.

Prior to the stock market downturn of 2008 and 2009, reverse convertible sales increased markedly, and nearly doubled in 2006 and 2007. Recently, news reports have suggested that some brokerage firms targeted senior citizens and other conservative, risk-averse investors in their efforts to sell reverse convertible bonds. Reverse convertible bonds were often misrepresented as safe, income generating investments suitable for retirees.

Unfortunately, when the stock market declined in 2008 and 2009, reverse convertible investors suffered massive financial losses.

Sometimes an investment advisor will misrepresent and/or omit material facts from his or her clients regarding the safety of their reverse convertible bonds. In fact, the advisor might even tell the investor that the reverse convertible bonds will help to preserve the investor’s retirement principal while generating a safe and reliable income. However, since reverse convertible “Nest Egg Slashers” are tied to the performance of stocks, they do not provide any kind of safety or protection from stock market volatility.

In my legal writing business, Strategic Legal Writing, I have assisted attorneys in rectifying some of the damages wrought upon investors who purchased reverse convertible bonds. Having witnessed their devastating affects, it is my opinion that the higher yields on these ‘designer’ investments are not worth the risks assumed by the investors who purchase them.