Strong demand from investors for catastrophe bond notes in the secondary market continued to have an offsetting effect on seasonal price movements in February, as issuance still fails to satisfy excess investor appetite for the asset class.
Seasonality, the movement of outstanding catastrophe bond prices according to the risk posed by seasonal perils, is something that has been muted over much of the last year. Investor demand for allocating capital to cat bonds has been so high that outstanding cat bond prices have become inflated, offsetting the effects of seasonality to a degree.
Interestingly it was about last February that we started to discuss the unseasonal movement of certain cat bond prices, as demand for the asset class rose. Despite a strong year of issuance in 2013, with $7.64 billion of new cat bonds recorded by Artemis, it has not been sufficient to soak up the excess demand meaning that secondary pricing remains under upwards pressure.
Primary cat bond issuance has been reasonably strong for the first-quarter of the year, with over $1.5 billion issued to date in 2014 (including some private deals), but this still hasn’t satisfied demand and investment managers are increasingly having to soft-close cat bond funds to new capital.
Every new cat bond issued in 2014 so far seems to have been oversubscribed and all have seen pricing settle at the bottom of, or below, the launch price guidance range. Of course this means that issuance conditions are extremely attractive which could help to bring more risk to market.
At this point the cat bond market likely needs at least a $10 billion year to even begin to soak up some of the excess demand from investors for cat bond investments. Until we see that sort of level of issuance, or higher, the secondary market looks destined to see rising prices and muted seasonality as a result.
Swiss-based ILS investment manager Plenum Investments said that February saw pricing of secondary cat bonds continue to rise due to strong bids, with European windstorm bonds among the biggest gainers as the winter storm season now draws towards its close.
U.S. hurricane bonds saw some declines, said Plenum, but the strong demand had an offsetting effect on expected seasonal price declines and also led to some gains on the price of U.S. earthquake positions.
With European windstorm bonds now moving out of the risk season and U.S. hurricane bonds being off-risk still, cat bond investment performance would be expected to be driven largely by earthquake and diversifying exposures at this point of the year. But with prices being inflated due to investor demand this trend is not as true as it was two years ago.
Craig Bonder, Managing Director and Head of ILS Trading at AK Capital, said; “Prices continued to rise slightly despite the reduction in the amount of risk free season remaining on US wind bonds. The market remains well bid and wishful for a robust issuance pipeline.”
Other ILS fund managers said that trading picked up in February and that demand led to a firming price environment once again. These firming prices help to boost the contribution that catastrophe bonds make to an ILS funds performance, so managers aren’t disappointed to see them.
For new ILS and cat bond investors or fund managers the above par pricing environment in the secondary market provides a quandary. Why buy a cat bond which is pricing 6 points above par when it only returns 5%? This adds to the interest in new primary issues, where cat bonds can be bought at par, but it is making it difficult to build a diversified portfolio from scratch.
Prices continue to rise through the beginning of March on many outstanding catastrophe bond marks, we are told, which suggests that still investor demand is not being satisfied. As the U.S. hurricane season approaches we may see some more typical seasonality return, but if primary issuance doesn’t keep accelerating this year any seasonality may once again be offset by investor demand for the asset class.
Read our article on the catastrophe bond trading environment in January: Investor demand for catastrophe bonds remains high in January.