Cat bond selling pressure drove record secondary market volumes in May: Icosa

Selling pressure in the secondary market for catastrophe bonds appears to have resulted in record levels of trading activity during the month of May, according to Florian Steiger, CEO of specialist cat bond investment fund manager Icosa Investments AG.

Given the swings in catastrophe bond spreads seen so far this year, with tightening through the start, that turned into widening later on supply and demand factors, as well as some hurricane season related influences, it’s no surprise that the secondary market, where cat bond notes are traded between funds and investors, has been busy.

The secondary market saw very strong demand for cat bonds at the start of the year, as cash from maturities and fresh inflows to some cat bond funds all needed to be put to work.

Then, as primary issuance of new catastrophe bonds picked up, the activity levels in the secondary market were sustained, as cat bond fund managers and investors needed to balance their portfolios.

Later still, we saw the correction in industry-loss index trigger cat bonds, which also stimulated trading activity, as well as broader spread widening that also led to opportunistic trades, all at a time of elevated primary cat bond issuance.

With elevated over-the-counter (OTC) trading of catastrophe bonds and rapidly adjusting prices at times, it’s made for a dynamic secondary market environment in 2024 so far.

Steiger, CEO of Icosa Investments AG, noted that, “Transaction activity in the secondary market has noticeably improved in recent years, leading to a significantly better liquidity situation for investors.”

Liquidity is critical, as it’s a selling-point for catastrophe bonds, with these assets tradable, at a price, on any day, meaning investors and portfolio managers can be tactical and manage their funds or allocations actively.

Steiger explained that, in H1 2024, “In the secondary market, based on our estimates, record volumes have also been traded this year, significantly improving the liquidity of this asset class.”

In fact, the cat bond fund manager’s CEO estimates that May could have been the busiest month ever for catastrophe bond trading in the secondary market.

“Based on our estimates, secondary market trading reached a new record level in the second quarter. April 2024 was likely the most active month of all time until May 2024 surpassed it,” Steiger explained.

Commenting on secondary market trading activity in recent months, Steiger also said, “Notably, the share of index-linked cat bonds that changed hands was significantly larger compared to new issuances.

“The price decline described by us, and the associated spread increases, were not just paper losses but occurred in actual trading.

“Parametric cat bonds, most of which are issued by the World Bank, were hardly present in the secondary market.

“In April and May, transaction prices were particularly notable. Many transactions took place (sometimes significantly) below the bid indications used by brokers for fund valuations, indicating substantial selling pressure among some market participants.”

It is important to note that identifying cross-trades in the cat bond market, where fund managers are trading via a broking desk between two of their strategies, can be a challenge and this makes tracking actual volumes between different investors or managers more difficult.

The cat bond fund manager’s CEO went on to state, “Our proprietary Icosa Indicator for investor interest in the secondary market also shows that the market was in strongly oversold territory in the second quarter.

“For market participants with capital inflows, this was, of course, a welcome opportunity to invest this capital very cheaply.”

Icosa Investments estimates secondary market cat bond trading volumes using a proprietary methodology based on date filed with Trace and its own estimates from trades and trading mix.

Based on this, Icosa believes the start of this year has seen record-levels of activity, including the biggest cat bond secondary market months ever.

The company also looks at investor sentiment in the secondary cat bond market, based on trading and price, as well as its own experience and so defines periods when the market is overbought or oversold, which is an excellent way to source additional inputs to inform its trading strategies.