FINRA Alert Cautions Investors on Speculating with Catastrophe Bonds and Other Event-Linked Securities

The Financial Industry Regulatory Authority (FINRA) issued an Investor Alert today warning investors about the risks of speculating on natural disasters with event-linked securities, such as catastrophe bonds or “cat bonds.” Cat bonds offer high yields but can quickly lose most or all of their value if a triggering event, such as a hurricane, earthquake or pandemic, occurs in specified geographical regions.

“Event-linked securities are complex products that can lose their value if a triggering catastrophe occurs,” said FINRA CEO Mary L. Schapiro. “While they are typically marketed to institutional investors, retail investors should know they could be vulnerable by virtue of owning shares in funds that invest in event-linked securities.”

The new Investor Alert, “Catastrophe Bonds and Other Event-Linked Securities“, describes how event-linked securities work and helps investors determine whether and to what extent the funds they hold invest in these securities. The Alert explains that prices, yields and ratings of cat bonds rely almost exclusively on complex computer modeling techniques that determine the probabilities and the potential financial damage of natural disasters. If a catastrophic or “triggering” event occurs, holders could lose most or all of their principal, the Alert cautions.

Investors are encouraged to check their funds’ prospectuses to see whether any fund is authorized to invest in event-linked securities-including collateralized debt obligations and derivatives. And investors should make sure that if a fund is invested in event-linked securities, it is diversified in terms of type of risk and geographic location, and event-linked securities comprise only a limited part of the portfolio.

Press release via Business Wire.

How will this affect the marketplace? Will it deter investors from putting their money into funds which have a portfolio that features insurance linked securities or are the types of investors who play in this market rather more willing to take on the risk in return for the high returns that are possible? We’d be interested to hear your thoughts, please comment.