ILS offers diversification when traditional stock/bond relationships falter: Omnigence Asset Management

Given insurance-linked securities’ (ILS) ability to offer a bounded allocation whose premium compensates for real and imperfectly correlated tail risk, a new paper by Omnigence Asset Management suggests that ILS remains one of the most credible candidates for diversification when traditional stock-bond relationships falter.

In the firm’s recently published report, executives outlined that the diversifying leg of the traditional portfolio depends on stocks and bonds moving in opposite directions, an assumption that has broken down in periods when inflation is elevated and correlations turn positive.

“Catastrophe bonds offer a return stream whose principal driver is a natural-catastrophe loss event, a factor with limited structural connection to the credit or equity cycle. Over the roughly two decades since the Swiss Re index began, the exposure has historically delivered equity-like returns with materially lower volatility, including three consecutive years of double-digit performance through 2025 as the reinsurance market repriced,” the report reads.

Importantly, the executives also highlighted how the Swiss Re Global Cat Bond Total Return Index has only recorded one negative calendar year since its inception in 2002, with that being in 2022, the year which saw Hurricane Ian cause roughly $65 billion of insured losses in the state of Florida.

Given this, Omnigence Asset Management states that a record this short, across a period that has not included a sustained clustering of severe insured-loss years, may understate the overall frequency and depth of drawdowns that a full loss cycle could produce.

“Two properties have historically distinguished the exposure. First, realized correlation to equities and credit has been low, because the loss driver is a physical event rather than an economic one — although that correlation can rise when ILS positions are sold to meet redemptions in a broad market drawdown, so the diversification is most reliable outside, not within, acute liquidity events,” the paper explained.

Adding: “Second, the floating coupon means income has risen with short rates rather than falling, so the exposure did not suffer the duration damage that hit both stocks and bonds in the 2021–2022 tightening. In combination, a modest ILS sleeve has historically improved portfolio Sharpe ratios at the total-portfolio level; whether it continues to do so depends on pricing, loss experience, and correlations that may not repeat.”

The company also highlights how US wind remains one of the largest perils within the cat bond market today.

Given how US hurricane and earthquake exposure sits as the largest risk on the insurance industry’s balance sheet, which according to Omnigence means a broadly held cat bond portfolio is, in practice, a “large bet on Atlantic hurricane and a smaller one on California earthquake.”

In fact, 2022’s negative year for the Swiss Re Global Cat Bond Total Return Index clearly illustrates this mechanic.

The Friday after Hurricane Ian struck Florida, the broad index fell by roughly 10% and the US-wind sub-index roughly 32%, according to Swiss Re Capital Markets.

Recent seasons further highlight this volatility: 2024’s Hurricane Milton moved the broad index by only 1.34%, while Hurricane Melissa in 2025 triggered a full payout on Jamaica’s $150 million IBRD CAR Jamaica 2024 parametric catastrophe bond, and early California wildfires also drove a negative return in January of the same year.

“When the correlation between stocks and bonds turns positive, the portfolio needs return streams that answer to something other than the economic cycle. Catastrophe risk may be one such stream: its driver is weather and geology, its coupon floats with rates, and its long-run record has paired equity-like returns with materially lower volatility,” Omnigence Asset Management added.

“The same features that make it potentially diversifying — a return earned by underwriting rare, severe events — also make it negatively skewed and peak-peril concentrated, and its short history may flatter both its return and its apparent stability.”

Concluding: “Held in that spirit, as a deliberately bounded allocation whose premium is understood as payment for a real and imperfectly measured tail, ILS may be one of the more credible candidates for diversification when the traditional stock-bond relationship becomes less reliable.”