Cat bonds a “positive outlier” in alternatives for 2024: Columbia Threadneedle

Catastrophe bonds offer investors a “positive outlier” in the world of alternative investments for 2024, according to global asset manager Columbia Threadneedle.

While remaining generally underweight alternatives, due to the proliferation of more traditional assets with improved returns in the higher rate environment, giant asset manager Columbia Threadneedle selects catastrophe bonds as a segment to watch.

The manager views many alternative asset classes as still attractive due to their diversification benefits, but stays underweight those where inflation has an influence.

Catastrophe bonds scored well in Columbia Threadneedle’s Capital Market Assumptions (CMA) model, in its outlook for 2024.

While these are seen as more risky spread products and the difference in returns with government bonds has reduced, the fact reinsurance pricing remains elevated and cat bonds float above the risk-free return causes this investment manager to continue to recommend them.

Columbia Threadneedle measures the performance of asset classes in the year to August and notes them as “a positive outlier” within the alternatives segment.

The investment manager explained, “The expected return for catastrophe bonds is determined on the basis of (forward) projections for the US money market interest rate in combination with a mean-reversion approach for the spread on Cat Bonds, minus a discount for the expected loss due to natural disasters. An adjustment is also made to hedge the currency risk.

“On a five-year horizon, this results in an expected return of 8.8%; that is high given an expected volatility of only 5.1% on this horizon.”

Going on to explain, “Apart from the fact that this category is structurally characterized by a low standard deviation compared to the return (the ‘cliff risk’ is not included in this risk measure), the spread is currently relatively high due to capacity limitations in the reinsurance market. The increased money market interest rates have also contributed to a higher expected return.”

Columbia Threadneedle joins the ranks of major asset managers singling out the catastrophe bond as an investment asset worth further exploration as we move towards 2024.

While the manager itself may not be a particularly large allocator to this asset class, compared to its overall asset footprint, the commentary will be noticed by its investor clients and other institutions, which is likely to drive further interest as cat bond returns continue on track to set new records in 2023.