Swiss Re Insurance-Linked Fund Management

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Portfolio rebalancing boosts secondary cat bond trading levels


Trading volumes in the secondary market for catastrophe bond notes have picked up in the last couple of months, according to investment managers and trading desks. The key reason for this heightened trading activity has been the high issuance seen in the primary market into June, but other factors also served to make the secondary market more active.

Primary cat bond issuance jumped again in late May and right the way through the month of June, with seven cat bonds completing in May, four in June and unusually five deals now set to complete in July (full details on them all can be found in our Deal Directory).

The issuance seen since May amounts to almost $2.7 billion worth of risk capital that has hit the market or continues to be marketed, so it’s no surprise that this surge of issuance has triggered higher levels of secondary cat bond trading as investors sought to balance their ILS portfolios.

It’s actually quite unusual to see such strong primary cat bond issuance running right into the U.S. hurricane season in July, especially so when most of the transactions feature U.S. hurricane risk, or in the case of the latest deal MetroCat Re U.S. storm surge from named storms. Typically the primary market turns much quieter by the start of June and we only really see diversifying perils come to market through the hurricane season months.

With such a high level of risk capital coming to market investors and investment managers have been busily offloading certain positions, in order to free up capital and space in their diversified portfolios for new deals. The increased level of issuance has now helped the market reach a more balanced level of trading, after the start of the year which saw unseasonal price rises on secondary cat bonds due to heightened interest and capital availability.

We asked Craig Bonder, Managing Director of the catastrophe bond trading desk at AK Capital, for his view on the trends seen in recent weeks in the secondary cat bond market.

Craig told us; “We have indeed seen an uptick in trading over the last few weeks. Seasonality and a continual stream of supply from new issues has countered the influx of capital and bond maturities that had left the market over weight buyers vs sellers causing higher pricing and limited trading. These factors have now created a better equilibrium of buyers and sellers. Allowing investors the opportunity to rebalance portfolios, and either take gains on early 2013 new issuance or deploy cash that could not have been fully invested in the first part of the year.”

The increased activity in the primary market, combined with investors need to offload positions, has resulted in a number of interesting trends in the secondary market. Pricing has declined in recent weeks, as evidenced by the Swiss Re cat bond indices, and this has had an impact on some investment managers with large cat bond allocations. Despite pricing declines, investors have also been able to capitalise on the price gains some positions saw before the declines kicked in and there has been an element of profit taking in some of the cat bond trading that has taken place.

Swiss based ILS investment manager Plenum Investments explained; “Secondary market trading has picked up during the last two months. Investors needed to rebalance their portfolios to make room for the newly issued bonds. This resulted in an increased supply of bonds in the secondary market and exerted downward pressure on the prices of outstanding bonds.”

The decline in secondary pricing has however been more delayed than in previous years, with the influx of capital and the need to put it to work in new issues resulting in demand for secondary marks boosting some prices. This has made the pattern of secondary trading in 2013 somewhat different to previous years.

Another Swiss ILS specialist investment manager, the LGT Insurance-Linked Strategies team, said recently; “The secondary market has remained lively this month as portfolio managers incorporate the new cat bond issues and optimise their holdings in preparation for the US hurricane season. We continue to see price correction on the secondary market for ILS as we head into the hurricane season,
however, due to the persistent, strong investor demand, the price movement has been held somewhat in check.”

Plenum Investments expects to recoup some of the mark-to-market price movements as we progress through the U.S. wind season. It said; “We expect the performance to increase more significantly during the course of the summer as we will see solid spread tightening returning on US hurricane bonds.”

Despite the stronger secondary cat bond trading it’s not, however, a picture of liquidity across the entire market. Craig Bonder of AK Capital explained; “Not all credits enjoy the same liquidity and despite the overall increased trading volumes there are pockets of low or no bids at times. All in all though the second quarter of 2013 reflected very positive signs for a growing market and we look forward to assisting clients as we move into risk season.”

The summer months are often a case of buy-and-hold for catastrophe bond investors, so the increased liquidity seen in the secondary market this year, while being a sign of the increased interest from new capital and investors, will also have been welcomed by those facilitating trading in cat bond notes. We’ll update you on trends in the secondary market for catastrophe bonds as we move through the 2013 hurricane season.

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