Cat bond spreads to remain at elevated levels: Plenum

With the collateral yield of catastrophe bonds at an all-time high and the insurance spread component at a 12-year high, it’s an extremely attractive time for the market, according to specialist asset manager, Plenum Investments.

During a webinar held yesterday, Plenum discussed the current state of the cat bond market and explored why it’s such a positive time for the space, as well as the outlook for the rest of the year and beyond.

Daniel Grieger, Managing Partner, Senior Portfolio Manager, ILS, Plenum, explained that the higher for longer interest rate environment is good for the cat bond market.

“As most of you will know, if we invest in a cat bond, our money is parked in three month treasury bills, and obviously at the end of the tenor of a cat bond, the money flows back to us in case of no loss, or to the insured or the sponsor of the cat bond who has bought the protection in case the cat bond is triggered.

“But what is important here is that the coupon of cat bonds consists of two components,” said Grieger.

One element is the money market component, the floating return that is generated, and the other part of the equation is the insurance spread.

“And if you look at the three months treasury bill, it is currently yielding 5.4%, and this is equivalent to a 22 year high. And remember the cat bond market has only been around for 22 years. So, when it comes to the collateral yield, it has never been as high as it is now,” said Grieger.

“And if we now look also at the insurance component. Also, here the discount margin as we call it, the spread, that is at a 12 year high.

“So, if we combine now a 22 year high for the collateral yield and a 12 year high for the insurance spread, we are in extremely attractive times for cat bonds,” he added.

Grieger, as well as Dirk Schmelzer, Senior Fund Manager, ILS at Plenum, highlighted that cat bonds again showed their benefit of being uncorrelated to financial markets in 2023, outperforming traditional asset classes.

Schmelzer noted that within the cat bond sector, drawdowns have been few and limited in size, especially when compared with those seen in equity, or other asset classes, and also hedge funds which had double-digit drawdowns.

“And as we’ve seen earlier, the spreads are still at record levels. They have come down from year-end, this is a combined effect from going through the hurricane season, some recoveries of bonds that were exposed to hurricane Ian, which ultimately did not cause significant losses to the capital markets and many of the cat bonds recovered, and some spread tightening on the newly issued bonds,” said Schmelzer.

“However, we see a very balanced supply and demand, and actually a lot of new primary market activity is expected for the fourth quarter of this year, bringing the issuance point to new record levels, and that will help keep risk spreads at elevated levels,” he added.