The Potential Roles of Cat Bonds in a Portfolio

Adding an allocation to cat bonds in your portfolio may offer several benefits.

1. Diversification

The key distinguishing characteristic of this asset class is that cat bonds are not influenced by the economic, financial and geopolitical factors that drive the performance of other traditional assets, such as stocks and bonds. Cat bond performance is distinctly uncorrelated as it is tied only to the occurrence of natural events and their impact on reinsurance capital losses. This makes them powerful diversifiers.

2. Lower portfolio volatility and higher risk-adjusted returns

Another potential benefit is that cat bonds can help reduce a portfolio’s volatility and improve risk-adjusted returns over the long term. Given that cat bonds tend to be uncorrelated to the financial markets, they can potentially help mitigate the losses that occur when most other asset classes decline together under market stress. This can result in an improvement to a portfolio’s risk/return profile.

3. Attractive income potential

Finally, cat bonds can offer attractive yields relative to other asset classes, floating rates and short duration. These factors can help deliver attractive return streams that may provide investors with an additional source of income that is uncorrelated to other assets.

The next video in this series will address how investors may consider funding cat bond allocations.

Follow @OppFunds for more news and commentary.