The Securities Litigation Expert Blog

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Posted by Jack Duval

Mar 24, 2020 9:23:37 AM

This is the first post in a series on the securities litigation likely to arise from the recent market declines.

Since the Global Financial Crisis ("GFC") in 2008-9, the Federal Reserve has keep interest rates at extremely low levels.

Indeed, at the end of 2007, the yield on the 10-year U.S. Treasury note was 4.0232 percent and at the end of 2011 it was 1.8762 percent.[1]  As I write this, it is at 0.69 percent.[2]

This has lead brokers and advisors to “reach for yield" for their investors.  Of course, they were able to grasp it, primarily by reducing high quality equity and fixed income investments and increasing:

  • Equity allocations;
  • Equity “bond proxy” allocations, and;
  • Low-quality fixed income allocations.

Over time, these combined shifts have led to an increasing amount of risk in investor's portfolios, even if the equity allocation did not increase (or even decreased).  Indeed, many investors have seen their portfolios become predominately equity exposed, greatly increasing their risk.  Table 1, below offers a comparison.

Table 1:  Typical Pre- and Post-GFC Portfolio Composition


Typical Pre- and Post-GFC Portfolio Composition

Table 1, above, compares typical investor portfolios from the pre- and post-GFC periods.  The yellow banded rows highlight investments with equity or equity-like exposure (even if they are bonds).

The pre-GFC portfolio has a 55/35/10 (stocks/bonds/cash) asset allocation, and is heavily skewed to quality on both the equity and fixed income sides.  The post-GFC portfolio has a 65/30/5 asset allocation, but has added 15 percent of equity “bond proxies” and lower quality fixed income.  (Equity bond proxies include equity investments such as traditional infrastructure, utilities, REITs, MLPs, and other higher yielding equities.)

Importantly, the direct equity exposure only increased from 55 to 65 percent, however, the total equity and equity-like investments increased from 60 to 85 percent.  From a risk perspective, the post-GFC portfolio is 85 percent in equities.

This is a significant increase.  And a bad trade.

In the 10-year rolling periods from January 2001 through June 2018, a traditional 60/40 portfolio returned an average annual 6.56 percent, whereas an 85/15 portfolio returned an average annual 7.13 percent, or 57 basis points higher.[3]

However, the increase in risk is dramatic.  Over the same period, the 60/40 portfolio had a standard deviation of 9.19 percent compared to 12.84 for an 85/15 portfolio.[4]

In percentage change terms, by shifting the equity (and equity-like) allocation from 60 to 85 percent, an investor gets an approximate nine percent increase in expected return, but a 40 percent increase in expected risk.  This is what made it a bad trade.

Worse still is the max drawdown risk of the two portfolios.  The 85/15 portfolio has significantly more drawdown risk.  Those risks are now being felt as the typical post-GFC portfolio proves to be much more highly correlated (i.e. where almost all the assets decline simultaneously) than most investors thought.

Hidden Fixed Income Risks

The litigations arising from the recent declines will likely have a common theme that was not present in those arising in post-GFC litigations:  hidden risks in investor’s fixed income investments.  All the risky fixed income investments that investors have been put into as part of the reach for yield are declining similar to equities, and in some cases more than equities.

These risky fixed income investments include those investing in the following underlying investments and/or strategies:[5]

  • Corporate bonds (which were typically around 50 percent in BBB rated bonds);
  • High yield “junk” bonds;
  • High yield municipal bonds;
  • Leveraged closed-end funds;
  • Convertible bonds;
  • Preferred stocks (almost all preferred stocks are issued through trusts which buy a note from the issuer and then sell interests in the trust);
  • Commercial mortgages;
  • Asset-backed securities;
  • Leveraged loans;
  • Collateralized loan obligations, and;
  • Emerging market bonds;

Table 2:  Bottom Decile One-Month Fixed-Income Mutual Fund Returns through March 20, 2020[6]

Bottom Decile one-month fixed-income mutual fund returns

The full list can be downloaded here.

Table 2, above, shows that the fixed income funds with the worst one-month performance through March 20, 2020, also generally had high, double-digit total returns in 2019.  These funds have fallen in-line with the S&P 500, which was down about 29 percent over the same period.

When reaching for yield, the handhold is risk.  The 2019 returns were the yield part, the previous months performance is the risk part.

In my experience, when bonds decline like equities, litigation ensues.

In subsequent posts, I will examine other aspects of increased risk-taking over the past 11 years.




[1]      Source: Bloomberg.

[2]      Id.

[3]      Goldman Sachs; Diversified Investment Allocation Tool.  Available at:;  Accessed March 20, 2020.  Dataset is the 91 10-year rolling periods from January 01, 2001 to June 30, 2018.

[4]      Id.

[5]      This list is by no means exhaustive.  All kinds of risky fixed income products have been invented over the past 11 years.

[6]      Source: Bloomberg.  Performance data for U.S. domiciled fixed income mutual funds with $500 million or more in assets, through March 20, 2020.


To learn more about suitability and fiduciary expert Jack Duval, click here.


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Topics: collateralized loan obligations, securities litigation, fixed income, Investment Suitability, commercial mortgages, CLO

Litigation Alert: Now Batting - Shale Bonds

Posted by Jack Duval

Mar 19, 2015 7:44:00 AM

The collapse in oil prices has been felt throughout the oil and gas industry, but nowhere as much as the in the high cost shale producers.

Goldman Sachs has produced a matrix of shale players according to their balance sheet and asset quality (HT ZeroHedge):


I've charted the bond prices of the Group Four companies (Low Quality Assets/Weak Balance Sheets):

(For a high res image, download this.)


The bonds of these highly leveraged shale players have performed in line with their speculative characteristics.  There is no recovery in sight because the only hope they have of making their bond payments is by producing more oil, which will continue to depress prices, which will make these firms less profitable, and less able to make their bond payments...

The gears have reversed and barring some geopolicital event, are unlikely to reverse again before many of these players exit the corporate gene pool.


For information about securities expert Jack Duval, click here.





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Topics: shale oil, bonds, securities litigation, fixed income, Securities Expert

Puerto Rico Municipal Bond Crisis - Adverse Tax and Trade Policies

Posted by Jack Duval

Nov 19, 2013 4:17:06 AM

Our expert analysis of the Puerto Rico municipal bond crisis continues with an examination of tax and trade policies that have negatively affected the island economy.  In particular, the timing of the expiration of Section 936 coincided with the start of the 2006 recession.

The Puerto Rico economy has been adversely affected by a number of changes in tax and trade policy.  Repealed by President Clinton in 1996 with a ten year phase out, Section 936 of the Federal Tax Code expired in 2006, helping to thrust the island economy into its long-run recession.  Section 936 was a tax incentive for U.S. companies to manufacture in Puerto Rico, allowing the repatriation of profits to the mainland U.S. without paying federal tax.  The pharmaceutical industry was a large beneficiary of this tax break and was a major driver of employment on the island.  According to a 2002 article published by the Pharmaceutical Industry Association of Puerto Rico, the pharmaceutical sector was responsible for 56% of total manufacturing jobs and 20% of total industrial jobs on the island.  The article states that although the pharmaceutical industry was able to largely maintain its tax advantages as an existing industry on the island, the expiry of the exemption was a significant disincentive for new industries to move to Puerto Rico.  27,373 industrial jobs were lost from October 1996 to September 2002.[1]  Additionally, included below is a reference table of historical Puerto Rican tax rates.

[1]                 Maldonado, A. W., “The Loss of 936: Good or Bad for Puerto Rico?” The Pharmaceutical Industry Association of Puerto Rico, November 17, 2002


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Topics: fixed income experts, Puerto Rico Municipal Bond Crisis, UBS, closed-end bond funds, litigation, investments, fixed income

Puerto Rico Municipal Bond Crisis - Unfunded Pension Fund Data

Posted by Jack Duval

Nov 16, 2013 3:17:01 PM

As part of our continuing analysis of the Puerto Rico municipal bond crisis, we have compiled data on the three pension plans funded by the Commonwealth of Puerto Rico.  The trend is clear at a glance - these pension funds have been chronically underfunded since at least 2000 and are headed for insolvency in the next year or two.

For our previous discussion of the Puerto Rico pension system, see this.

For a higher resolution version of this chart:  Puerto Rico Municipal Bond Crisis - Unfunded Pensions.

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Topics: Puerto Rico Municipal Bond Crisis, unfunded pension, litigation, investments, fixed income, municipal bond expert, UBS closed-end funds

Puerto Rico Municipal Bond Crisis - Unfunded Pension Funds

Posted by Jack Duval

Nov 12, 2013 3:56:18 AM

In our continued expert analysis of the Puerto Rico municipal bond crisis, we are looking at the unfunded pension plans of the Commonwealth.


When the ratio of workers to retirees falls, state pension systems become strained.  If the trend continues, the pension system becomes unsustainable.  In a healthy pension, the support structure can be visualized as a pyramid, with many contributors at the base supporting few pensioners at the top.  However, as the large base of contributors ages there can be fewer contributors to fund the pension, especially if population growth stalls and life expectancies increase.

If this occurs, the structure of the pension system shifts from a pyramid to a diamond to an inverted pyramid.   Once inverted, there are few workers supporting many pensioners and the pension is on a crash course with math.  Funds are being drawn down at an accelerating rate and being replaced at a declining rate.

Unfunded pensions systems are a significant risk to an economy because investment and savings are diverted for wealth transfers to pensioners.  This dampens long-term growth and can open the door to social unrest as both contributors and pensioners view the pension system as unfair.

Puerto Rico Pension Plans

As could be expected from the trend of declining population, the Puerto Rico pension system is chronically underfunded.  There are five main public pension systems in Puerto Rico.  They include:

  • Puerto Rico Government Employees Retirement System (“PRGERS”);

  • Puerto Rico Judiciary Retirement System (“PRJRS”);

  • Puerto Rico Teachers Retirement System (“PRTRS”);

  • Retirement System of the University of Puerto Rico (the “University Retirement System”);

  • Employees Retirement System of the Puerto Rico Electric Power Authority (“PREPA”).

The University Retirement System and PREPA are funded independently by the revenues of their respective corporations, the remaining plans are funded by the Commonwealth.  We examine the three Commonwealth plans below.

The three Commonwealth administered plans are shockingly underfunded.  In total, they have plunged from a 24.8% funded ratio in 2007 to only 8.4% in 2012.  For comparison, the U.S. state of Illinois is considered the worst funded pension system among all of the states; its system was reportedly funded at 43% in February 2013[1].  In isolation, the PRGERS (the largest system of the three with approximately 200,000 current and retired workers[2]) is the worst, showing a $26.4 billion unfunded accrued actuarial liability (“UAAL”) as of June 30, 2012 (the most recent valuation date) and only a 4.5% funded ratio.  The

PRJRS and PRTRS are funded at 14.1% and 17.0% as of June 30, 2012 respectively.  As is clearly demonstrated in the exhibit, all three pension systems are quickly approaching insolvency, and their fates have only been worsening as they consume current assets to feed current obligations.[3]

It should be noted that Governor Padilla signed into law a series of reforms affecting the PRGERS in April 2013.  These included raising the retirement age for some workers to 65, increasing pension contributions by almost 2%, and lowering monthly pensions and benefits for some state workers.  In addition, state workers’ Christmas bonuses were reduced and summer bonuses were eliminated.[4]  Encouraging as these reforms are, however, it remains to be seen whether they will be enough to counteract long building and deep structural imbalances.

[1]                 All details on the Puerto Rico pension plans were taken directly from their respective actuarial valuations.  See the Reference Section for details.

[2]                 “Puerto Rico Senators Approve Public Pension System Overhaul,” Id.

[3]                 Kaske, Michelle, “Puerto Rico Set to Boost Worst Funded Pensions Sans Debt,” Bloomberg,  February 22, 2013

[4]                 Anonymous, “Puerto Rico Senators Approve Public Pension System Overhaul,” Reuters, April 4, 2013,


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Topics: municipal bond crisis, CEF, Puerto Rico, UBS, unfunded pension, litigation, investments, fixed income, expert opinion

Sustainable Withdrawal Rates - Revisited

Posted by Jack Duval

Nov 11, 2013 4:02:16 AM

William Bengen, the financial advisor who created one of the most heavily cited studies on sustainable withdrawal rates, is backing off his previous findings.  (Barron's)  Bengen's 1994 study (Journal of Financial Planning) concluded that a portfolio balanced 50/50 (stocks/bonds) could sustain a four percent withdrawal rate though almost all market scenarios.  (Importantly, Bengen's analysis assumed the four percent was set off of the initial premium amount and then was adjusted each year for inflation.)

Bengen's hedging should be obvious to anyone in the financial planning business.  Yields on stocks have fallen and yields on bonds have plummeted, making it very difficult to create the required returns without capital appreciation.  This simple fact requires advisors and investors to make a difficult decision:  settle for lower withdrawal rates, or take more risk.

From the big moves in junk bonds, master limited partnerships, and other high-risk investments, it appears that many advisors and their clients have opted to take more risk.

As many have warned, this has usually ended badly.  See here, here, and here for our previous discussion of yield chasing.

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Topics: yield chasing, sustainable withdrawal rates, investments, risk, fixed income

Buyers Panic Continues in High Yield

Posted by Jack Duval

May 14, 2013 4:19:00 AM

The Barclays US Corporate High Yield Index has now closed at a yield of 4.97%, the lowest in the index's 30-year history, Reuters reports.  (TR)  For the week ending May 8, $789M of new money flowed into high yield.  Here are some quotes that should scare everyone:

... There was "indiscriminate" buying in the high-yield primary market... CCC+ rated payment-in-kind toggle offerings (are getting done)... XM Radio launched a single tranche US$500M seven-year non-call three senior note offering partly intended for share repurchases... there's nothing you can buy in the secondary market right now, it's all bid... high-yield bonds have become as sensitive to rising rates as high-grade bonds, because there is no spread cushion left.

When PIK bonds are back you know we have entered the land of the lotus eaters.  I'm afraid many investors needing income will be taking large haircuts when Odysseus comes to drag them away.
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Topics: junk bonds, Senior Investors, investments, PIK bonds, yield bubble, fixed income

FINRA Issues NTM Regarding Unlisted REITs

Posted by Jack Duval

May 7, 2013 4:58:50 AM

FINRA has issued NTM 13-18 Communications with the Public, providing guidance on communications with the public concerning unlisted REITs and DPPs.  (NTM 13-18)  Several things are of note:

1. As always, providing a prospectus does not satisfy the required disclosures in written and oral communication.

 Providing risk disclosure in a separate document, such as the prospectus, does not substitute for the required disclosure, even if a communication is accompanied or preceded by a prospectus.

2. Firms may not state the distribution rate is a "yield" or "current yield".  This is because distributions have historically included a return of principal.

3.  Firms may not imply that the values of the fund are stable just because they are offered at the initial offering price.

 The fact that a program offers its securities at par value, or at another relatively stable price, does not evidence stability in the value of the underlying assets.  A communication also may not state that the price at which the program is offered is stable or that its volatility is limited without disclosing that price stability does not indicate stability in the value of the underlying assets, which will fluctuate and may be worth less than the real estate program initially paid, and that the investor may not be able to sell the investment.

4. Firms may not compare the performance of an unlisted REIT to a listed REIT.

Compliance and supervisory personel would be wise to implement this guidance when conducting their reasonable basis suitability determinations, review of advertising, Registered Representative communications, and customer specific suitability.  Especially in light of investor's yield chasing.

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Topics: FINRA, Apple REIT 10, suitability, investments, supervision, REIT, DPP, SEC, fixed income, Compliance, regulation.

Student Loan Bubble Update

Posted by Jack Duval

Apr 15, 2013 3:14:16 AM

Here's a link to the New York Federal Reserve PowerPoint on the state of student loans.  (NYFR)  Fun facts:

  • 44 percent of borrowers are not in repayment yet;

  • 1/3 of borrowers who are in repayment are delinquent

See our previous coverage of the student loan bubble here.
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Topics: New York Federal Reserve, Student Loan Bubble, investments, fixed income, debt

The Yield Bubble - China Edition

Posted by Jack Duval

Mar 29, 2013 4:05:53 AM

Yields on Chinese junk bonds have fallen by 30-40 percent over the past two years, as the hunt for yield goes global.  (NYT)  If "Chinese High Yield Debt" doesn't put the fear of God in you, read this:

Chinese junk bonds also have a unique structure, which could leave investors vulnerable.  Mainland China’s domestic bond market remains largely off limits to foreign buyers. So most investors buy offshore Chinese bonds, which are issued through holding companies headquartered in places like the Cayman Islands.  The bonds tend not to be backed by the actual businesses and underlying assets in mainland China. That means foreign bondholders may have little legal recourse if a company defaults on its debt, especially if local banks or other Chinese creditors make claims.

Investment advisors should be checking any high yield funds they have for China exposure, as this will surely end badly.
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Topics: investments, high yield, yield bubble, fixed income, China, debt

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