3 Reasons to Consider a Cat Bond Strategy

The primary reasons to consider an investment strategy that includes cat bonds are diversification, attractive yields and the potential of improving risk-adjusted returns.

1. Diversification

Cat bonds are not typically sensitive to global financial markets because their value is tied to the occurrence of natural events such as hurricanes and earthquakes. This attribute means they can offer an uncorrelated return stream to traditional assets including equities and fixed income. For this reason, they have the potential to meaningfully enhance diversification and possibly smooth out returns across market cycles, while lowering portfolio volatility and ultimately improving risk-adjusted returns over the long term.

2. Yield

Holders of cat bonds receive a premium for assuming the reinsurance risk of a catastrophic event. This premium is paid to the investor as part of the bond’s coupon. If no events occur, the investor enjoys the enhanced coupon for the term of the bond, and receives the principal back at maturity. If a trigger event occurs, all or part of the principal is transferred to the insurance company, and coupon payments are reduced or stopped. Cat bond premia has generally ranged from 5%-7%, allowing investors to earn attractive yields compared with other investments in the current low-rate environment.

3. Risk-adjusted returns

Cat bonds have historically delivered strong returns over the past 10 years primarily due to the fact that investors have seen more negative impacts from events driven by economic and financial market stress, rather than events based on natural perils that have been catastrophic to the insurance industry.
Given the opportunity to improve diversification and risk-adjusted returns with an attractive yield generated by cat bond coupons—we believe investors can consider incorporating cat bonds into their allocations to enhance their portfolios.

Our next video in this series will address our philosophy and process of investing in cat bonds.

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