Investors seeking yield need look no further than catastrophe bonds

In the financial markets, the term yield is used to describe the return that investors make or expect to make from their investment in a security. It has a number of different definitions depending on the usage but with an example asset such as insurance-linked securities or catastrophe bonds it can best be thought of as amount of cash that investors will make from the coupons, or interest payments, they receive for investing in a specific ILS or cat bond.

With the financial markets still suffering thanks to the Eurozone debt crisis, uncertainty over the U.S. economy, fear of a global recession and now the fear of a prolonged slowdown in growth in China, it has become increasingly hard for investors to find reliable sources of yield. One of the few asset classes which offer a reliable yield right now is the insurance-linked securities and catastrophe bond market, as well as the broader spectrum of reinsurance investment opportunities.

Catastrophe bond returns have been increasing in recent weeks, partly due to the seasonal influence of the U.S. hurricane season and the fact that the season has thus far not resulted in any major losses, but also as catastrophe bond price returns have been recovering from a dip in prices at the start of this year. This has led to many catastrophe bond fund managers and investors making increasingly impressive returns over the last few months, which has helped to underscore the attractiveness of the ILS asset class.

Cat bond price returns as measured by the Swiss Re indices have now reached their highest levels since late March 2011, after the drop in price returns caused by the earthquake and tsunami disaster in Japan. This is encouraging and will show investors that the assets react as expected, although the dip after the Japan quake was perhaps rather larger than might have been expected given the relatively small number of exposed bonds.

According to Bloomberg in this article published today, demand for catastrophe bonds is increasing as investors chase returns while facing record-low yields from speculative grade corporate debt. Dollar denominated cat bonds have been yielding an average of 9.4% above short-term lending rates, while junk bonds can only offer an average spread of 5.4% according to Bloomberg data.

The article from Bloomberg contains a great quote from Bill Keogh, President of risk modelling firm EQECAT. Discussing the catastrophe bond market and its attractiveness to investors at a conference, Bill Keogh said; “People want yield, and that’s where you get yield. I don’t know where else you could get yield these days.”

That’s a true and very telling statement which goes a long way towards explaining why the cat bond, ILS and reinsurance asset class is getting so much attention right now. Investors are desperate to find assets which can meet their target return profile and cat bonds and ILS are one of the few which currently offer enough yield. The fact that the yield from cat bonds is relatively uncorrelated with the broader financial markets is another important draw for investors. For investors who are struggling to find yield and attractive returns in their typical corporate debt and equity type markets it’s clear that they need look no further than the catastrophe bond market for an attractive source of yield.

With returns recovering to pre-disaster levels, increasing amounts of capital entering the space or on the fringes seeking to enter, a so far benign hurricane season and the most important reinsurance renewals of the year approaching in January, the conditions look ripe for the cat bond and ILS market to grow even further.