Cat bonds demonstrate low-correlation to financial markets in August

by Artemis on September 22, 2015

Levels of trading in the secondary market for catastrophe bonds dropped in August, despite global financial market volatility, as the summer holidays hit the appetite to trade and investors looked to hold positions to benefit from seasonal spread tightening.

The secondary market for cat bonds has seen reasonably high levels of trading in recent months, as investors have been swapping in and out of positions, some to shift focus more to collateralised reinsurance, others to maintain portfolio diversification, still more to accommodate new ILS deals.

August is typically a slower month, not least because in a major catastrophe loss free environment, as we see today, the spread tightening effect of seasonality on U.S. wind and hurricane catastrophe bonds makes holding more attractive than selling for many investors and ILS managers.

This has been particularly true in 2015, following secondary price declines for the majority of outstanding cat bonds through the first-half of the year. That means the seasonal effect has perhaps been more apparent than in previous years, with greater gains seen in July and again in August on some positions.

This has led to some ILS fund managers and pure cat bond fund managers being able to report attractive returns for July and August, as secondary prices recovered and seasonality really came into play.

Craig Bonder, Managing Director at AK Capital, explained some of the market forces at play in August, saying; “We saw mixed flows this August as summer holidays, limited new issuance, and just a threat of weather activity all weighed down on trading volumes.”

With Atlantic hurricane activity remaining well below historical levels, positive development on secondary marks allowed many investment managers holding catastrophe bonds to benefit during the month of August.

Zurich, Switzerland based ILS and cat bond investment manager Plenum Investments noted that secondary cat bond market activity was “muted” during August.

Even the occurrence of two tropical systems in the Atlantic during the months could not put a dampener on the seasonal market to market price recovery among cat bonds.

Plenum Investments explained; “Tropical storms Danny and Erika did not pose a threat to CAT Bond. Therefore, spreads on CAT bonds continued their typical seasonal tightening.

But perhaps most notable in August was the ability of the catastrophe bond and insurance-linked securities (ILS) market to once again demonstrate its largely uncorrelated nature, versus the world’s financial markets.

With volatility apparent in many of the world’s stock markets, led by China’s share prices crashing, cat bonds and ILS had a very positive month and once again showed that as a diversifying asset class they make a valuable contribution to investor portfolios in times of global stress.

Bonder of AK Capital explained; “As wall street and main street focused on the volatile stock and corporate bond markets the Cat Bond market hummed along as usual with seasonal and demand induced tightening.

“Another positive bit of evidence for the non correlated diversifier bulls of insurance linked securities.”

Plenum also noted that seasonal spread tightening occurred in August “irrespective of the strong increase in volatility in the stock and corporate bond markets.”

When financial market’s near crisis point, as China’s stock market looked set to do, investors look for asset classes which can be immune from the effects of the macro-economic environment. Catastrophe bonds, insurance and reinsurance linked investments are such an asset class, with little in the way of links to corporate stock and bond performance and returns mostly linked to the occurrence of major catastrophe events.

Whenever the market’s become volatile ILS and cat bonds once again display the benefits of adding an asset with very low levels of correlation to your portfolio. August will once again have helped to raise ILS’ profile as an asset class among the world’s institutional investors.

Looking ahead, September is typically a peak month for the Atlantic hurricane season, which means that the seasonal effects should be even greater than August. So if the tropics remain quiet and cat bonds remain unthreatened by other events, the spread tightening could be even greater this month allowing ILS funds to anticipate another positive month’s performance.

Also read:

Active cat bond trading in July, as performance turns positive.

Cat bond funds drag average ILS fund return to 0.17% in June.

Catastrophe bond market ripe for the “picking” in May.

Pricing pressure persists in secondary cat bond market during April.

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