Over the last year many of the lower yielding catastrophe bonds have actually made more attractive investment opportunities, on a risk adjusted basis, according to Swedish cat bond and ILS investment fund manager Entropics Asset Management AB.
Sponsors of catastrophe bonds have increasingly been seeking to lower the risk adjusted returns on higher yielding issuances, or on a cat bond that offers investors a diversification opportunity. Essentially investors have been paying for access to these deals, in terms of the lower multiple to expected loss that many offer.
ILS and cat bond fund manager Entropics noticed this trend during the year and argues that some of the lower yielding cat bonds, while perhaps not offering the returns some investment managers have been used to, can offer an attractive way to enter the asset class with allocations that provide a good risk adjusted return.
“After the financial crisis and the ensuing low central bank interest rates, we have seen a race for returns, with downwards pressure on multiples for high-yielding assets,” CEO of Entropics Robert Lindblom explained.
“This is true also for cat bonds, where bonds with a high expected loss (EL) and thus high yield today have multiples lower than two. We also see the drive for diversifiers as diversifying bonds can have low multiples despite the low EL,” he continued.
Investors have been willing to give away more on price, on a risk adjusted basis, in order to access higher yielding cat bond notes or true diversifiers throughout 2015. Meanwhile the multiples on lower yield, lower risk, U.S. peril cat bonds have stabilised first, while the higher yielding issues in particular continued to see multiples decline right up to the end of the year.
But while the multiples had been on the wane many cat bonds continue to offer what Entropics sees as attractive risk adjusted returns.
Lindblom explained; “However, nearly half of the issued volume in 2015 still had a multiple above 3. These are mainly bonds with an EL below 1.5. For an investor that primarily is concerned with risk adjusted performance, who also is willing to accept some concentration risk, this indicates an excellent opportunity to build a portfolio with excellent risk-adjusted performance in this environment.”
Of course this leads to a difficulty for many ILS fund managers, with the lower yielding bonds more attractive on a risk adjusted basis but not providing the returns they need to maintain overall targets. This has led to some managers of pure cat bond funds increasing the level of risk, or the expected loss, of their portfolios in 2015 in order to maintain a certain level of return.
A good example of the appetite for higher-yielding cat bond notes happened just this week, with the XL cat bond Galileo Re 2016-1 pricing at the low end of already reduced guidance, as investors showed their willingness to assume more risk in return for a higher coupon.
For large pension funds and institutional investors looking for a low-volatility, relatively uncorrelated, 2% to 5% above the risk free rate of return, however, the lower yielding catastrophe bonds could make a good investment allocation. Hence these bonds may eventually find themselves increasingly acceptable, as investors seek to de-risk in the continuing volatile global capital market.
For sponsors of cat bonds, the insurers and reinsurers looking for protection, it is in their interest to keep paying these multiples for more remote covers in order to keep the gates to the capital market open and stimulate more interest from investors.