Cat bond liquidity evident, as trading rises on Covid-19 volatility

The catastrophe bond market is once again demonstrating its financial liquidity, as secondary trading volumes have risen driven by certain investors looking to sell their positions at a time when volatility in the broader financial markets is extremely high due to the coronavirus pandemic.

Catastrophe bonds have demonstrated their liquidity benefits for investors before, of course.

During the 2008 financial crisis, the catastrophe bond was one of the few assets that was easily sold and had plenty of buyers.

At the time that drove a broad shake-out of the ILS investor base, as more speculative investors such as hedge funds largely exited the reinsurance-linked investing space, welcoming the chance to cash in their positions. While more specialist investors and the ILS funds that existed at the time bought up the available and often discounted cat bond notes and grew their ILS funds.

The ongoing global Covid-19 coronavirus pandemic and the resulting extreme volatility seen in financial markets and asset prices has once again made it an attractive time to sell your catastrophe bonds, if you’re not a specialist investor in them.

There are many investors who buy catastrophe bonds that aren’t ILS funds, or even alternatives specialists, given the rising awareness of insurance-linked securities (ILS) and catastrophe reinsurance as an asset class.

The cat bond has become popular as a low-correlation, reinsurance risk-linked asset, with many multi-strategy fund managers and an increasing number of mutual funds in the U.S. also have the ability to buy cat bonds, as just one of a range of fully securitised assets their prospectuses allow them to allocate to.

The result of this has been a gradual diversification of the cat bond asset base into more traditional multi-strategy investment funds, as the popularity and awareness of cat bonds rose in recent years.

But these investment funds, which are more traditional and less specialist in nature, are the ones now facing significant losses and write-downs in the value of almost all of their more-correlated asset classes. Hence they are now seeking to raise cash for redeployment, or to fund redemptions, or just to get rid of any assets they can.

Of which one of the most easily saleable right now seems to be the catastrophe bond.

Looking at cat bond trading data from a few sources, including FINRA’s Trace system, the catastrophe bond market has actually been particularly liquid since around mid-February.

Partly that will have been due to higher levels of primary cat bond issuance, as the market is set to break issuance records for new cat bonds this quarter.

But secondary trading activity picked up significantly last week and even more into this week as well, with a chance that the current week could see one of the most actively traded cat bond marketplaces for quite a long time.

It’s clear that there are some investors selling down their catastrophe bond portfolios at the current time.

This is made apparent by the fact there are long-dated names, including those whose pricing should not be seasonally affected right now, that are trading at a few bps below par (further below par than would normally be expected).

Which suggests there are investors who are willing to sell at a slight discount, in order to liquidate their catastrophe bond positions and perhaps entire cat bond portfolios. While on the other side of these deals are likely to be the specialist cat bond fund managers and other ILS funds, who have the capital available to allocate to this opportunity at this time.

We understand some fresh bid lists were submitted yesterday, some with very short timescales being targeted, with one investor describing the activity as a “rush to liquidity.”

This is a buying opportunity for the dedicated cat bond fund manager and ILS investors, for which holding cat bonds and other reinsurance linked assets is their entire mandate and so the volatility in the financial markets is not a concern.

But if cat bonds are just a smaller component of a portfolio of securities, then selling what you can at prices just below par value seems like an attractive thing to do right now to benefit from the cash this liquidation can provide.

The coronavirus pandemic has provided another demonstration of the relatively uncorrelated nature of catastrophe bonds as well, given nobody would be buying anything correlated unless they were at far more distressed pricing at this point in time.

The fact trades are getting done at just a small discount to par shows that these assets are still extremely attractive right now, to those investors for who cat bonds are a priority or main investment strategy.

While, for investors that cat bonds are a nice to have for, at different points in the financial market cycle, this becomes a welcome selling opportunity instead.

The cat bond once again shows its benefits and attraction to both sides of the current trading activity, acting as a saleable source of cash for those more traditional investors in need at this time. While presenting a very attractive and largely uncorrelated asset buying opportunity for the more specialist investors and funds for who catastrophe bonds are once again a particularly attractive asset class.