WSJ on Reverse Convertibles: "Risky Strategy Offer Lucrative Payouts, But Could Cause Steep Losses"

Risky Strategy Lures Investors Seeking Yield
Popular 'Reverse Convertibles' Offer Lucrative Payouts But Could Cause Steep Losses

By ELEANOR LAISE
Wall Street Journal
March 26, 2008; Page D1

Wall Street is luring income-hungry investors with complex securities that come with big risks as well as extravagant yields.

The products -- called "reverse convertibles" -- are typically linked to the performance of a single stock like Apple Inc. or AT&T Inc. and often offer yields ranging from 7% to as high as 25% or more. Sales on these notes have been soaring as yields on many fixed-income investments have been sinking. Small U.S. investors snapped up $8.5 billion worth of reverse convertibles in 2007, up 81% from 2006, according to Arete Consulting LLC, which tracks the products.

At Incapital LLC, a distributor of reverse convertibles, sales doubled in 2007 from a year earlier, says Chief Executive Tom Ricketts. The notes are issued by firms such as Morgan Stanley, Barclays PLC and ABN Amro Holding NV. The companies whose share prices are linked to reverse convertibles have no involvement in the products.

For small investors, reverse convertibles offer a high level of income for a low minimum investment. But investors typically don't participate in any gains in the underlying stock, and if the stock falls sharply, they can lose much of their investment. Regulators have grown increasingly concerned about how complex "structured products" such as reverse convertibles are marketed to small investors, and they're pushing issuers to closely monitor their sales practices.

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