Liquidity in the secondary market for catastrophe bonds rose in December, as an active period of primary cat bond issuance combined with the approach of the key January reinsurance renewals, stimulated investor portfolio rebalancing.
As is typically the case, the primary issuance market for new catastrophe bonds came to life at the end of the year, with $1.25 billion of broadly marketed issuance and a $57m private cat bond all completing during the month.
Whenever primary cat bond issuance activity picks up investors and insurance-linked securities (ILS) fund managers tend to prepare for investing in new issues by rebalancing existing portfolios, in order to accommodate new deals, which naturally results in a more active period of buying and selling.
In December, with the key January reinsurance renewals fast approaching and many ILS fund managers actively involved there as collateralised providers of reinsurance capacity, the need to sell is often greater. Some managers have been shifting increasingly towards private ILS and collateralised reinsurance, resulting in more selling of cat bond positions around the main renewal seasons.
Craig Bonder, Managing Director at AK Capital, explained; “The year ended with strong activity in both primary and secondary markets. Primary markets saw $1.25 billion in issuance with another $300mm already announced for 2016. This issuance helped spur portfolio rebalancing across names and perils leading to quite an active month in secondary trading.”
The impact of selling pressure can have an effect on pricing though and this was evident in the secondary cat bond market in December. This caused some lower returns for ILS and cat bond funds, but still the majority were positive for the month.
“This activity at times heavy, weighed somewhat on prices but for the most part the market ended the year strong and we saw a positive overall month,” continued Bonder.
Zurich, Switzerland based ILS and cat bond investment manager Plenum Investments also noticed the same trends, explaining; “The secondary market was active, due to the strong primary market issuances.”
“The new emissions resulted in many ILS funds rebalancing their portfolios across names and perils, which also had some effects on secondary market prices; price decreases across all major risk classes except for Europe wind storm and Japanese risks,” Plenum continued.
So the pricing pressure was not uniform, perhaps more focused on the peak perils of U.S. wind and quake risks. Seasonal pressures should have been removed from the market by now, so any decline in outstanding cat bond prices is largely due to supply/demand dynamics and the need to diversify portfolios.
One final factor noticed in the cat bond market in December was that new the risk adjusted returns on new issuances were aligned with those much earlier in 2015, which suggests that the compression on price and returns have stabilised on cat bonds, Plenum noted.
2016 is expected to see much more stability in secondary cat bond marks, with price compression stabilising. However, the effects of capital inflow, high levels of primary issuance and of course seasonality will continue to ensure that prices on secondary cat bonds fluctuate.