Currently, the insurance-linked securities (ILS) and broader reinsurance market environment provides long-term investors with a good entry point into the catastrophe bond market, according to Florian Steiger, a portfolio manager at Twelve Capital.
Despite a notable slowdown in growth in more recent times, driven by consecutive years of heavy cat losses, loss creep, trapped collateral and a generally more sophisticated and disciplined sector, alternative reinsurance capital continues to expand.
Outside of the collateralised reinsurance space, the catastrophe bond market is the largest sub-sector of the ILS industry, and as shown by the Artemis Deal Directory, continues to expand its remit and reach, in terms of perils, regions, and structures, year after year.
Steiger, the portfolio manager responsible for Cat Bond strategies at Zurich headquartered insurance and reinsurance linked specialist investment fund manager, Twelve Capital, explained in a recent note why increased cat bond diversification, among other factors, supports entry into the marketplace.
“Many new perils and regions have come to the market and the overall market size in existing peak perils has also grown,” said Steiger.
In recent times, the perils covered by catastrophe bond transactions has grown significantly, and now includes things like terrorism, standalone flooding, standalone wildfire, mortgage insurance risks, and Atmospheric perils. At the same time, cat bonds now cover perils in more regions than ever before, and increasingly provide coverage for less developed parts of the world such as Colombia, Chile, and Peru.
“From a portfolio management perspective, this is positive as it gives more optionality to portfolio managers… Overall, diversification possibilities within the Cat Bond market have increased considerably in the last two years,” continued Steiger.
Rapid ILS market growth occurred during a prolonged softened reinsurance market which then experienced one of the largest catastrophe loss years in its history.
Owing to its increased influence on the reinsurance sector, ILS funds were unsurprisingly hit by 2017 losses, and while investors hoped for a less active 2018, a number of new events coupled with prior year loss creep had a substantial impact on cat bond prices through 2018 and into the start of this year.
According to Steiger, the prices of cat bonds are now at the lowest seen for some time, and, even when accounting for contributions from distressed bonds, “It is clear that Cat Bonds have rarely traded at more attractive levels over the last five years.
“Not only did price levels move considerably towards the upside, but general negotiation power has also shifted in favour of investors this year – a stark contrast to the first half of 2017. Twelve Capital sees this as a healthy development even if it might lead to of a short-term drag on Cat Bond prices due to the spread-widening of existing transactions.”
He added that supply in the secondary market appears to be sufficient to meet diversification needs, while enabling the absorption of even a large influx of capital into the asset class.
“While wider financial markets experienced substantial volatility in 2018, most Cat Bonds lived up to investors’ expectations and acted as diversifiers across portfolios. Investors who held Cat Bonds over the past two years as part of their strategic asset allocation to alternative assets generally earned higher risk-adjusted returns compared to portfolios without any ILS exposure despite the number of natural catastrophe events,” said Steiger.
Another reason that now might be a more favourable time to enter the market is the fact the wind season is approaching, which is typically a good entry point for investors as a result of seasonality aspects driving strong cat performance.
Despite failing to reach the heights of the first-quarter of 2018, cat bond issuance in the opening three months of 2019 remained very strong, with the overall market achieving outright growth once again.
The outstanding catastrophe bond market size is approaching the $40 billion mark, while the range of perils, structures, and regions on offer to investors is also on the rise, suggesting further market expansion moving forward.
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