Total return of the catastrophe bond market beats 10% in 2012

by Artemis on January 3, 2013

The total return of the outstanding catastrophe bond market in 2012 beat the long-term average to come in at an impressive 10.3%. After a sluggish start to 2012 the total return of the market, as measured by the Swiss Re Global Cat Bond Performance Total Return index, climbed strongly through the rest of the year. This clearly demonstrates the attractive returns that can be made by a dedicated investment in a diversified portfolio of catastrophe bond notes.

The only blemish on an otherwise impressive year was caused by hurricane Sandy, which resulted in a drop of the total return index of around 2.85%, meaning that the annual total return could have been nearer 13% had Sandy not struck the U.S. northeast and affected market confidence and pricing.

According to Swiss Re the average annual return of their index from 2002 to the end of 2011 was 8.13%, so 2012 has beaten the long-term average by over 2% which is again impressive. The S&P500 only manages an annual average return of -1.06% over the same period.

The lack of volatility is one of the key attractions of the cat bond market as an investment opportunity. The ten-year average volatility of the cat bond total return index is around 2.75% while the S&P500 sees volatility of around 16% on average. In 2012 while the cat bond market returned 10.3% the S&P500 actually beat it returning around 13% over the course of the year. However 2011, which wasn’t a banner year for the cat bond market thanks to catastrophe events such as the Tohoku earthquake, saw the cat bond total return index finish the year having returned around 3.59% while the S&P500 was in negative territory for the year. The level of volatility exhibited by the return of the cat bond market is one of its key selling points for investors, alongside diversification and its lack of correlation with broader financial markets and economic indices.

Of course the Swiss Re total return index, which tracks the total return of a basket of natural catastrophe bonds, is not typical of the real-world investment opportunities available to investors. Most ILS funds are not focused on cat bonds only, and if they are solely focused on securitized cat bonds then they tend to be a little more conservative due to diversification. TheĀ Eurekahedge ILS Advisers Index is a good representation of the returns possible across the cat bond and ILS investment universe, however that index has not yet published an annual return as it waits for data from investment managers. Up to the end of November the ILS Advisers Index had returned 4.82%, so looks set to finish the year above 5%.

That is inline with the annual return of hedge funds around the world, which returned on average 5.5% in 2012 according to HFR. High-yield bonds provided a better year for investors in 2012, helped by governments central bank policies, however again the volatility and year-to-year returns here cannot compete with cat bonds.

It’s easy to see why catastrophe bonds, insurance-linked securities (ILS) and catastrophe reinsurance-linked investments are growing in popularity. The attractive returns, low volatility, low correlation and portfolio diversification features continue to attract investors capital to the space. It’s expected that this trend will continue through 2013 and observers are forecasting another banner year for the sector. Whether the total return of the cat bond market will beat the 10.3% seen in 2012 we cannot be sure, but overall the asset class continues to prove its worth to investors globally.

You can see the rise of the cat bond total return index during 2012 in the chart below:

2012 catastrophe bond total returns

2012 catastrophe bond total returns as measured by the Swiss Re Global Cat Bond Performance Total Return index

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