2012 demonstrates catastrophe bonds lack of correlation to wider capital markets

Catastrophe bonds and insurance-linked securities are viewed as an asset class which can offer exceptional market-beating returns and which are largely uncorrelated to the broader capital markets. They’re also viewed as something that investors should generally be prepared to commit capital to for a reasonable length of time in order to achieve the returns that they are seeking and the diversification within their portfolio from the wider financial markets.

Looking at data on cat bond performance from 2012 gives a perfect demonstration of both of these features of cat bonds as an asset class, thanks to the decline in price returns in the secondary cat bond and ILS market and the movements in a number of other financial asset benchmarks.

A recent article on cat bonds from the Economist Intelligence Unit, which discusses the high demand that the asset class is seeing right now, contains some interesting data on the returns of the cat bond market in 2012 versus a number of other benchmark indices. It also compares the performance over a longer period of time, from 2007 to present. For cat bonds the article uses the Swiss Re Global Cat Bond Performance Total Return Index as an indicator. The data included can be seen below:

Catastrophe bond returns versus other benchmark indices

So as you can see from the above, in 2012 cat bonds have underperformed a number of other asset class indices. Equities have seen a very good year (perhaps until the last week or two) and have outperformed cat bonds by a lot, other indices have not outperformed by so much but have still returned at least double the amount that cat bonds have. So recently, on a short-term basis, cat bonds were perhaps not the best investment choice.

However, as we said, cat bonds and ILS are generally seen as a longer term commitment. This becomes evident when you look at the right hand column in the graphic above and see that over a longer period they easily outperform all of the other indices. As our readers will be aware, the decline in cat bond price returns is expected to slow/stop over the next few months and the market is going through an active stage of issuance right now so the short-term performance has been no surprise to sophisticated investors who understand the value of cat bonds as part of their portfolios.

On the subject of correlation, the above graphic gives a pretty clear message. Over both the short-term and long-term performance periods, cat bonds performed very differently to the wider capital and financial market indices. Hence why investors like them as a diversification tool within their portfolios.

The final point we’d make on this data is that the recent performance underscores the need to educate investors on cat bonds and ILS as an asset class. An onlooking investor with little knowledge of the sector would be forgiven for thinking that it has underperformed and is not as attractive as the other indices and asset classes. Through education and gaining an understanding of the features of the asset class, investors can be helped to understand that the real opportunity within the cat bond and ILS space is for market beating returns over longer periods of time and a great diversifier within their broader portfolios.