The Financial Industry Regulatory Authority is advising consumers to look to see whether their mutual funds or other funds have invested in bonds linked to pandemics and other catastrophes.
“Event-linked securities currently offer higher interest rates than similarly rated corporate bonds,” officials at FINRA, Washington, write in an investor alert. “But, if a triggering catastrophic event occurs, holders can lose most or all of their principal and unpaid interest payments. This is precisely what happened to funds that owned bonds linked to U.S. hurricane risk when Hurricane Katrina struck.”
Catastrophe bonds pay higher interest rates than similarly rated traditional corporate bonds, and some argue that investors are overcompensated for the risk they assume by buying cat bonds, FINRA officials write.
In addition, cat bonds help perform differently than typical stocks and bonds perform in a bear market, officials write.
“Bear in mind, though, that the effect of natural disasters on financial markets is not well-studied or foreseeable, and that past performance is no guarantee of future returns,” officials write.
“Since individual retail investors generally cannot invest directly in event-linked securities, you will want to find out whether any funds you own invest in cat bonds or other similar event-linked instruments,” officials write. “Check your fund’s prospectus and statement of additional information to see whether your fund is authorized to invest in event-linked securities–including CDOs and derivatives–and if so, how much.”
When reading the documents, investors should consider whether the fund manager has adequate resources and expertise to evaluate the risks of event-linked securities, FINRA officials conclude.