Cat bond sell-off may slow new issuance until ILS fund inflows catch up

With catastrophe bond trading in the secondary market having reached what may well be record levels on the back of the Covid-19 coronavirus pandemic related sell off, thoughts turn to how this significant increase in liquidity may impact the wider market over the coming months.

As we explained last week, the catastrophe bond asset class has once again demonstrated its lack of correlation to broader financial markets, as well as the liquidity benefits it offers investors, as many more generalist funds holding catastrophe bonds have opted to sell their positions.

Brining back memories of 2008, when many investors sold their cat bonds as a source of cash during the financial crisis, hard hit generalist and multi-strategy investors are currently doing the same, as the Covid-19 coronavirus outbreak has wiped billions off the values of other asset classes.

So far this cat bond selling activity has been matched by sufficient demand from specialist insurance-linked securities (ILS) funds and other investors such as pensions, for who buying up often long-dated cat bonds in bulk at below par prices is an opportunity too good to be missed.

Some of the UCITS cat bond fund managers have been able to allow a little extra inflow from investors into their funds in response to the large bid lists that have been offered in the last week and we understand there is a chance of further inflows being allowed into these funds over the coming weeks.

As a reminder, many of the UCITS catastrophe bond funds had been closed over the last year, as issuance while brisk had not been sufficient to allow for fresh capital to be raised until into the first-quarter of 2020.

But this current pandemic related sell-off and cashing in of catastrophe bond positions by more generalist investors has to have some ramifications going forwards, one of which may be a hit to (or slowing of) the new issue pipeline for cat bonds.

After what looks set to be a record first-quarter of new catastrophe bond issuance in 2020, the expectation had been that the second-quarter of the year could be even more impressive, in terms of issuance volumes coming to market.

Estimates suggest that as much as $500 million of cat bonds have been sold off in around the last ten days or so, as these multi-strategy investment funds looked to cash in one of the only asset classes that could be liquidated at close to par pricing.

We’re told that names such as Bailie Gifford and AXA Investment Managers are among those that brought lists of cat bonds to market in the last fortnight.

We also understand that some mutual funds have been offloading cat bond positions in expectation of redemptions at month-end.

At this stage it’s not clear whether Stone Ridge or Amundi Pioneer, the best known mutual fund manager’s in the ILS market, is among them. There are plenty of other mutual funds that have allocations to cat bonds, as the asset class has been added to so many prospectuses in recent years.

Looking forwards, what could this mean for cat bond issuance and ILS renewals?

There are significant levels of catastrophe bond maturities ahead, with around $7 billion expected across full-year 2020 and some $5 billion plus when you count a number of private cat bond deals in Q2 alone.

As a result of the maturity cycle, the cat bond investment market had been anticipating at least a replacement of that issuance through the second-quarter of the year, as well as a number of new sponsor cat bonds that have been in the work for some months already.

But, with cat bond funds making as much as they can of the opportunity to buy up the lists of cat bonds being put up for sale, capital is being used on the current buying opportunity which could cause an impact to forward plans.

As many multi-strategy investment funds and other more generalist investors are exiting the cat bond market in search of cash at this time, as it’s one of the only asset classes where that is possible at pricing close to par right now, there could be a dent to available capital to support Q2 cat bond deals.

So, the key to Q2 catastrophe bond issuance may well be the ability of the specialist cat bond and ILS funds to raise new capital and welcome new fund inflows, which given the current financial market volatility caused by the Covid-19 coronavirus cannot be guaranteed at this time.

Broker dealers and structuring houses are going to have to canvas the ILS market carefully to ascertain just what level of new issuance can easily be supported through the second-quarter of the year.

With the reinsurance renewals ahead in April and June/July, which will also put demands on available ILS capacity, there is the potential for a bit of a crunch in capacity for the market that could make it more challenging to support all new issues, as well as all private ILS and collateralised reinsurance or retro renewal needs.

But sources suggest there shouldn’t be too much concern, as investor interest is still evident, especially from those allocated to ILS funds for a number of years and for who this is a core diversifying asset class with significant prospects right now.

The fact cat bond funds have been filling their portfolios with notes that are often long-dated and purchased at below par, as well as the fact the pressures from the coronavirus outbreak will likely support reinsurance and retrocession rates, both mean that entry, or allocating more capital, to the ILS market at this time is particularly attractive and perhaps advised.

As a result, it’s likely that some fresh investor inflows will be received, helping to support issuance and renewals.

But, a slowdown could be seen and it may be harder for certain ILS deals to get across the line than others over the coming months until the volatility caused by the Covid-19 coronavirus outbreak stabilises somewhat.