Swiss Re Insurance-Linked Fund Management

PCS - Emerging Risks, New Opportunities

Cat bond funds expect prices and returns to stabilise


This year has been much harder than normal for the managers of cat bond funds and insurance-linked securities funds. More used to giving their investors great, non-correlated returns on a regular, monthly basis, cat bond funds have had to get used to monthly declines and a pattern of negative returns over the course of 2011.

Over the course of 2011 so far most cat bond funds and ILS funds are down in the region of 1% to 3% with the average being 2%. This compares with returns of 5% to 9% in a normal year.

The reasons for the poor or negative return during 2011 are many and when you look at the big events which affected the catastrophe bond and ILS market over the course of the year, it’s easy to see why funds remain in negative territory at this late stage of the year. We’ve had the earthquake and tsunami in Japan which of course caused a cat bond, Muteki Ltd. to default and become a total loss. Then we had the updates to the RMS U.S. hurricane risk model and the impact that had on expected losses for some cat bonds. Next the record-breaking U.S. tornado season, which took the scalp of the Mariah Re cat bonds, causing one series of Mariah Re to become a total loss and the other series to trigger and lose investors some of their principal. On top of that we’ve had hurricane Irene threaten cat bonds which cover the U.S. northeast population centres, hurricanes Jova and Rina threatened the MultiCat Mexico cat bond and earthquakes threaten the Ianus Capital cat bond in Turkey. All of these events have contributed to negative returns, falling secondary market prices and lower than expected issuance over the year. So by averaging 2% down cat bond funds have done all right really.

The pattern is going to (or maybe already has) change(d) though and most cat bond funds, unless they had a particularly large exposure to Mariah Re, have been managing positive monthly returns for the last quarter or so. The investment managers we’ve spoken with lately are all broadly positive for the future as they expect the returns to continue to be positive and secondary market pricing to return to a more normal pattern.

Swiss based private bank and ILS investment fund manager Clariden Leu said in their latest monthly fund report that they expect secondary market prices to stabilize over the coming months as cat bond and ILS issuance increases in the primary market.

Given the end of the U.S. hurricane season is almost upon us some hurricane exposed secondary market cat bond prices have been increasing, reflecting the decreasing risk of a major storm striking the U.S. Clariden Leu say that the strong gains will decrease on these positions and they also say there may be an increase in selling of bonds. Any increase in selling is likely to constitute part of the process of investment managers freeing capital and adjusting portfolios to accommodate new issuances and maintain a better overall diversification for their investors.

Clariden Leu themselves have seen roughly a negative 2% return on their funds over the course of 2011, however for them all of the negative came during March and since then the fund has managed a positive return every month from April. They expect the positive returns to continue over the coming months and they say that they expect their long-term performance targets will be achieved. They caveat this by saying that this is clearly subject to the occurrence of any large insured disaster events.

So despite the negative territory that most cat bond funds have found themselves in over the course of 2011 the future looks brighter and more stable with cat bond funds we’ve spoken with unanimously expecting to see a much more positive Q4 and start to 2012.

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