Bond Losses Expected to Lead to Increase in Investor Unsuitability Claims
By Thomas J. McNamara
Estimates are that the global bond market lost more than $1 trillion in value in the couple of days after President Trump’s surprise election. While the stock market was buoyed as a result of President Trump’s election, the bond market experienced the opposite result. The prospect of increases in infrastructure spending and greater deficit borrowing led to expectations of higher inflation and interest rates. The price of bonds varies inversely with interest rate direction and higher interest rates lead to a decrease in the value of bonds. The loss in the value of bonds is more acute with long-term 20 and 30 year bonds, as long-term bonds are more interest-rate sensitive and have greater volatility than short term bonds.
A 1% increase in the 30 year T-bill rate could lead to a 20% loss of principal. Bondholders who can afford to hold onto their bonds until maturity will, absent default, continue to collect their interest payments and receive their principal back upon maturity. However, bond investors who must sell their long-term bonds prior to maturity will suffer a loss of some of their principal in a rising interest rate environment. Many investors are not aware of the risk to principal they are assuming in the purchase of long-term bonds.
Brokers may have liability for making unsuitable investment recommendations to their customers. Whether a particular recommendation is suitable under the circumstances depends upon a whole host of factors, including, but not limited to, the customer’s age, other investments, financial situation and needs, tax status, investment objectives, investment experience, investment time horizon, liquidity needs, risk tolerance, and any other information that may be applicable. Given the large losses which bonds have already suffered, a surge in unsuitability claims against brokers, particularly by older investors, alleging that long-term bonds were not suitable investments given their age, time horizon, liquidity needs, and risk tolerance, is to be expected.
Thomas J. McNamara in a Partner in the Commercial Litigation Practice Group at Certilman Balin and an Adjunct Instructor of Business Law at Molloy College.