Media reporting of disasters drives cat bond alpha opportunity: John Seo, Fermat

The way mainstream media report on natural disasters and severe weather events is likely to present an opportunity for catastrophe bond fund managers to generate alpha over the coming years, according to John Seo of Fermat Capital Management, LLC.

As with any growing market, as its scale increases and the number and types of participants, investors in this case, also expands, the chance of media reporting becoming relevant to the insurance-linked securities (ILS) market is increasing.

When the mainstream media sensationalises disaster events it can even cause price movements, John Seo, Co-Founder and Managing Director of ILS and catastrophe bond focused investment manager, Fermat Capital, believes.

Which has ramifications going forwards, especially as climate change becomes an increasingly high-profile media concern.

Speaking to investors recently, Seo explained, “I think that the greatest source of alpha in our market, going forward, is really the media dynamic.”

While you might think the ramifications are most significant for live cat type events, for example when a hurricane is in the water and approaching land and secondary cat bond prices may move, Seo pointed out that this media dynamic is also relevant to primary issuance of catastrophe bonds.

“What we’re seeing is that secondary trading in particular, but also primary issuance – the reaction of investors to primary issuances, is being increasingly media driven,” Seo explained.

“That’s really our greatest opportunity for alpha generation because it’s not the media’s job to calibrate the message around the threat of natural catastrophes.

“They’re reporting on it in a way that has, frankly, an element of entertainment to it, but not measure, and that can cause extreme discrepancies between prices of bonds in the secondary and even in the primary market versus reality,” he continued.

Media reports can heighten nerves among investors and so sensationalising disasters could become a particularly relevant factor in ILS.

We have an asset class where values are tied to the measured and perceived risk of a position and a market where an increasingly wide range of investors are entering, and this is only likely to expand going forwards.

Which means that when a disaster event is sensationalised in the media it can create market-moving momentum that could affect the secondary price, particularly in the so-called live catastrophe situations where an event is on the verge of occurring or has just occurred.

But as the ILS and catastrophe market continue to expand, media could even be a driver for primary issuance pricing, as Seo suggests, as the same media-driven nerves could move perception of a risk to a degree that investors adjust their pricing.

It’s a savvy observance by Seo, as in most capital markets there is a definite and very evident media dynamic, which can sometimes become a significant factor.

We’ve seen this in mortgage-backed securities markets and in the last year it’s become increasingly evident in areas of investing such as the IPO market.

It’s also possible to imagine an expansion of the types of media that are relevant to ILS to include social media as well, especially when you consider the way the recent GameStop situation played out for some investors.

In that case, amateur traders ganged up via social media platform Reddit to target the GameStop stock, with a goal of hurting short traders by inflating the share price, resulting in huge losses in some quarters.

The power of media, social media and of crowds of motivated, normal investors, was laid bare in the GameStop example, showing how markets, or assets, can be moved by a surge in media activity.

The rise of climate related activism could in future become a relevant piece of the media dynamic Seo describes, as numerous catastrophe bonds are linked to perils many would immediately class as closely linked to climate change related factors.

Which could open the cat bond market up to a growing chance of media-linked price movement, given the high-profile nature of climate and the activism that can surround it.

What does this mean for the ILS market, its fund managers, and investors?

It means that increasingly the ILS market will need to be media aware and keep abreast of waves of news media and social media closely linked to the large disaster scenarios that can drive losses, or that are related to the ILS perils issued and traded.

Of course, it also makes having your own in-house views of risk and access to necessary risk modelling and analysis tools even more important, which could help ILS managers and investors to capitalise on any emergent alpha opportunity created by media coverage.

Also read: ESG credentials of ILS attracting new investors & issuers: John Seo, Fermat.