For cat bonds to reach their potential, investor needs must be met: K2 Advisors

K2 Advisors, the hedge fund focused investment management unit of Franklin Templeton, is bullish on the outlook for the catastrophe bond market in 2023, but longer-term believes investor needs must continue to be met.

As we reported recently, K2 Advisors has raised its investment conviction level for the insurance-linked securities (ILS) asset class.

The investment manager is particularly constructive on catastrophe bonds, having been so for a number of quarters now as yields have steadily improved.

But, with reinsurance rates having risen considerably at the end of last year, K2 Advisors has now moved its overall conviction on ILS to overweight and currently has a strongly overweight view on cat bonds, private ILS and retrocession investments.

“We believe the current ILS market environment presents investors with what could be one of the best entry points since the inception of the asset class,” the company explained in its recent update on hedge fund strategies, including ILS.

But, while higher yields and improved terms of coverage mean the reinsurance market as a whole has higher return-potential, the investment manager notes the need to maintain discipline.

At the same time, the investment manager believes that cat bonds in particular are becoming increasingly relevant for insurers seeking reinsurance and should see increased demand, especially while reinsurance capital has become more depressed.

K2 Advisors caution though, that in order for the catastrophe bond to reach its potential, the needs of investors must be kept front of mind and adequate returns must be maintained.

“For the cat bond market to play the much more important role in providing capital to support catastrophe, weather and climate related risks, investor needs must be met, which will include a push for higher premiums and clearer structures,” the investment manager stated.

A statement that resonates with investor sentiment at this time.

Many investors are looking much more favourably at cat bonds and ILS in the higher yield and priced environment we currently see.

But those investors that have experience in the ILS sector are conscious that gains made during hard market periods of the past, have often been given back as capital flows in and softening of pricing resumed.

Increasingly, both investors and managers appear keen to make the new ILS yield environment much stickier than has been seen in the past, with K2 Advisors just the latest from which this type of sentiment has come to light.

It’s going to be interesting to see how sticky higher spreads and yields prove to be through 2023, especially once more consistent inflows of capital are sourced by managers.

K2 Advisors is right though. Meeting investor needs is critical to the health and expansion of the ILS and cat bond market.

But, so too is meeting cedent needs, when it comes to coverage, which can make for a delicate balance to maintain, given reinsurance capacity on the traditional side is also likely to expand as the year progresses.