Activity in the secondary trading market for catastrophe bonds and insurance-linked securities (ILS) was a little slower in February, partially due to lower primary cat bond issuance but also as the month is typically one of consolidation.
After the activity of the fourth quarter and the January renewals, followed by a period of portfolio adjustment in January, typically February can be a little slower as ILS fund managers focus on the pipeline towards the key mid-year reinsurance renewal season.
Some activity continued as a result of ILS managers switching out of cat bonds and into collateralized reinsurance at the renewals as Artemis wrote recently here, resulting in a need for selling of positions through the start of the year. There was also continued evidence of investors that require the liquidity of a cat bond taking advantage of any higher-yielding notes that were offered.
Investors tell us that competition for the higher-yielding notes can be quite high, as they are clearly in demand, resulting in some being priced above investors expectations. However, someone is buying the higher-yielding cat bonds that become available, no matter what the price.
Zurich-based ILS and catastrophe bond investment manager Plenum Investments commented that; “Secondary market trading was quiet in February, mainly due to the low primary market activity.”
However pricing in the secondary market continued to follow seasonal trends. Plenum explained; “The prices on CAT bonds followed their usual behavior with US hurricane bonds decreasing on average by 1%, European winter storm bonds gaining on average 30 basis points and all other risk classes stayed on average flat.”
Spread widening on U.S. hurricane bonds slowed cat bond fund returns in February. However there is an expectation that such widening will begin to slow down as the market seeks to equalize prices across primary and secondary dealing resulting in better performance for cat bond portfolios.
The main secondary ILS and cat bond trading desks reported a reasonably consistent flow of deals during February, but perhaps with more interest than execution as prices remain too rich for some investors and ILS managers (again particularly on higher-yielding notes).
Seasonal trends, the expectation of new issuance, the search for higher-yielding bonds, the rotation from cat bonds to collateralized reinsurance and also the need for new issuance to diversify portfolios, are all factors affecting pricing and trading of cat bonds and ILS so far in 2015.
There remains some concern of prices still being too high on some secondary positions, which has really been the case for well over a year now. However this has been driven by market forces, inflows of capital, primary issuance peaking over short periods and now demand for vintage, higher yielding bonds.
Those factors likely won’t disappear from the market until (if) we see levels of primary issuance that actually satisfy investor demand. Given the way the pipeline looks, even with the busiest part of the year for issuance fast approaching, it looks unlikely that we’ll see the level required to soak up some of the excess investor demand for risk in securitised form.
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