Cat bonds for investors
Du you wonder how cat bond investments work? On this page, we answer many common questions about what investors can expect from the asset class.
This page answers questions about investments, but you can also read our description of how cat bonds work.
In principle, cat bonds are fairly simple. A cat bond is like a corporate bond, with a defined regular coupon. However, the risk is not a corporate default, as with corporate bonds, but that a predefined insurance damage occurs. But there are also some other important differences. Cat bonds are fundamentally uncorrelated with the equity markets, which means that cat bond returns do not follow the development of global stock markets. A stock market crash does not trigger a hurricane and natural catastrophes have historically not caused long term economic damage to global stock markets.
From the launch of the primary index of cat bonds, Swiss Re Cat Bond Index, cat bonds have had good risk adjusted returns, with total returns at par with equity markets. This is largely due to the fact that cat bonds have not been affected by the large losses to equity in the periods 2002, 2008 and 2011.
Common interest bearing instruments, such as corporate bonds, tend to be sensitive to interest rate changes, where increased interest rates decrease market values. Cat bonds are designed as floating rate notes, where the risk premium is paid on top of the risk free interest rate. If the interest rates increases, so does the return. The interest rate sensitivity is very low, and market values are thus only marginally affected by changing interest rates.
Below, you find answers to many questions from our blog.
What kind of returns can I expect?
Cat bonds have in the past 20 years had a total return on par with the equity markets. The total cat bond sphere, as measured by the commonly used index Swiss Re Cat Bond Total Return, has historically returned 8.7% per annum on average in the past decade This gives a total return of 130.7% in ten years, slightly above the total return on the stock markets in the same period. The return is highly due to the uncorrelated nature of cat bonds, which have left them largely unaffected by a number of drawdowns, most notably the financial crisis in 2007-2009, affecting most traditional asset classes. Read more.
Do I carry an interest rate risk?
For fixed income instruments, such as cat bonds, the sensitivity to interest rate variation is very important to investors. Any investment in fixed-income instruments, such as traditional government or corporate bonds, or cat bonds, carries an interest rate risk. Cat bonds are, however, structured in a manner that minimises this risk. Read more.
When is the right time to enter the market?
Several factors – the diversification challenge in a low interest environment, expected new emissions and increasing supply of new perils on the market – indicate that cat bonds presently are an interesting option. Read more.
Are the bonds really uncorrelated?
One of the largest advantages of cat bonds is that they are fundamentally uncorrelated to other asset classes. A financial crisis does not trigger earthquakes. A deeper analysis also shows that large natural events do not affect broader markets, though they naturally have a large local impact. Read more.
How is a portfolio affected by allocation to cat bonds?
A traditional investment portfolio complemented with cat bonds would be expected to deliver more stable returns. Looking at the past ten years, a traditional portfolio, allocated to Swedish and foreign equity and bonds, would have delivered higher returns and a lower volatility with a cat bond allocation. Read more.
How do cat bonds compare to corporate bonds?
Both cat bonds and corporate bonds are fixed income instruments so it is relevant to compare the risk premium of cat bonds with similarly rated traditional corporate bonds. Currently, cat bonds pay a higher risk premium compared to similarly rated corporate bonds. Read more.
Video: A brief introduction to cat bond investments
Fund investments entail risk. The value of investments in funds can increase as well as decrease and investors can loose all or some of the investment. Historical return is not a guarantee of future returns.