Cat bonds demonstrate positive diversification characteristics: Plenum

The catastrophe bond market has been demonstrating its “positive diversification characteristics” during the ongoing Covid-19 coronavirus pandemic, according to specialist ILS fund manager Plenum Investments.

The catastrophe bond asset class is one of the best defensive asset classes in these times of financial market volatility and great uncertainty, with the cat bond once again demonstrating the benefits of liquidity and lack of correlation, as we explained recently here.

Plenum Investments is a Zurich-based asset manager with a focus on catastrophe bonds, so well-positioned to comment on how the market is responding in this challenging time.

“Given the current turmoil in the international financial markets Plenum would like to point out that the CAT bond market is again proving its positive diversification characteristics,” the investment manager explained in a communication.

Plenum noted that pandemic risks and mortality exposure remain a relatively small piece of the overall cat bond and insurance-linked securities (ILS) market, so the specific exposure to the coronavirus outbreak is minor.

“Attributable performance losses are small and already included in the current prices,” Plenum said, which refers to the marking down of some positions in the secondary market on the expectation of potential impacts.

But at this time cat bonds demonstrate their positive characteristics for investors, offering a relatively insulated safe haven against broader financial market volatility.

Plenum explained, “CAT bond structures contain the lowest possible credit risks. In particular, they are immune to cedant default and the collateral in the form of US Treasuries or IBRD notes is of the highest credit quality. Thanks to their short duration characteristic, the interest rate risks is minor and offers additional protection against inflation.”

In a highly volatile investment climate this is part of what makes the catastrophe bond such a defensive asset class to invest in.

The other side of it is of course that, largely, cat bonds are exposed to the risks of major reinsurance claims caused by natural catastrophe events, so are removed from financial market factors.

However, financial market forces and investor appetite can affect the market in other ways, as Plenum explained.

“Like any financial investment, CAT bonds are also exposed to changes in supply and demand. The stable performance of CAT Bonds and large losses on other investments, have caused a relative overallocation in many investment portfolios. The rebalancing of portfolios has already led to selling pressure across all market segments, resulting in slight price markdowns on positions traded on the secondary market,” the cat bond fund manager explained.

Adding, “These reduced price levels offer attractive buying opportunities, which some investors are already taking advantage of. The increase in risk premiums resulting from these price adjustments is not driven by an increase of risk of insured natural disasters.

“There has been no change in the quality of CAT bonds and no impairment has taken place.”