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Be aware of risks in structured notes, junk bonds

Investors seeking higher returns should be aware of the risks in buying structured notes, junk bonds and leveraged loans amid record-low interest rates, according to the Financial Industry Regulatory Authority.

Investors may be tempted to "chase" returns by buying "riskier and sometimes complex" products as yields on many fixed-income investments are at historically low levels, the industry-backed regulator said.

"Higher returns come with higher risk," said Gerri Walsh, Finra's vice president for investor education. "Never make an investing decision solely by looking at an investment's return, whether past or projected."

The warning comes amid record issuance of structured notes and junk bonds as the Federal Reserve keeps benchmark interest rates near zero, pushing investors into riskier, higher-yielding debt. Mutual funds that buy leveraged loans have reported net inflows every week for more than a year.

Speculative-grade companies have issued $187.2 billion of notes in the U.S. this year, compared with $130.2 billion during the same period in 2010, according to data compiled by Bloomberg. Investors funneled $1.59 billion into high-yield bond funds in the past two weeks, following record outflows of $7.1 billion in June, according to JPMorgan Chase & Co. analysts, citing Lipper FMI.

Mutual funds that invest in leveraged loans have reported 55 straight weeks of net inflows, the analysts, led by Peter Acciavatti in New York, said in a July 22 report. High-yield bonds, also called junk, and leveraged loans are rated below Baa3 by Moody's Investors Service and less than BBB- by Standard & Poor's.

Junk debt has returned 93 percent since the end of 2008, while leveraged loans have gained 57 percent, according to the Bank of America Merrill Lynch index and the S&P/LSTA U.S. Leveraged Loan 100 Total Return index.

U.S. structured-note sales in the first half of the year climbed 14 percent to a record $25.3 billion in the first six months of 2011, from $22.2 billion a year earlier, Bloomberg data show.

The Finra alert, titled "The Grass Isn't Always Greener Chasing Return in a Challenging Investment Environment," comes less than two months after the regulator warned about structured notes with "principal protection." That alert aimed to educate buyers about risks of the products "that may surprise many investors."

Structured notes are securities created by banks, which package debt with derivatives to offer customized bets to investors while earning fees and raising money. Derivatives are contracts whose value is derived from stocks, bonds, currencies and commodities.