Catastrophe bond market swells as natural disasters become more intense
The catastrophe bond market is growing so rapidly it has exceeded $40 billion for the first time ever, highlighting a fast-growing interest from investors as the impact of climate change becomes more apparent.
The growth trend coincides with the greater frequency of natural disasters and emphasises the ongoing need for insurance for losses related to catastrophes, according to a new report shared with Net Zero Investor.
Due to the complexity and uncertainty of this market, catastrophe bond strategies are typically more suitable for sophisticated investors with long investment horizons and no immediate liquidity needs.
The $40 billion mark means the catastrophe bond market has doubled in size in just ten years, according to research from Artemis.
This is still relatively small compared to some markets. In comparison, the global bond market has risen to more than $140 trillion in assets by the end of 2022, compared to around $60 trillion in 2005, according to the Bank for International Settlements.
However, "the appeal of this market is its lower correlation to traditional bond and stock markets due to the unpredictable nature of weather-related disasters, and potential for higher returns," Morningstar noted in a new report.
"The concept is as such: if a disaster doesn’t occur, the investor will receive their money back plus interest," explained Mara Dobrescu, director of fixed income research at Morningstar.
Also, if a disaster does occur, the investor can lose some or all of their money depending on the cost to the reinsurer.
"The concept is as such: if a disaster doesn’t occur, the investor will receive their money back plus interest."
As of June 2023, Morningstar’s global database included 46 funds focused on catastrophe bonds and private insurance-linked securities, for a total of $16.5 billion.
Lumpy
The fund universe is "lumpy" - as the researchers put it: funds managed by GAM, Schroders and Twelve Capital take up the lion’s share of assets, which could raise potential capacity concerns.
On average, funds in the catastrophe bond cohort delivered on their promise of outperforming the broader global bond market and delivering low correlation to most traditional asset classes.
“This higher risk and potential for individual bonds to experience significant losses means diversification is key when investing in a catastrophe bond strategy," Dobrescu pointed out.
"The challenge for this asset class is that despite the years of data on such naturally occurring events, reinsurance companies try to assign reasonable probabilities to the occurrence of a specific event, but they lack any consistent predictability, particularly as climate change introduces additional uncertainties.” she added.
Dobrescu did stress that fund managers charge relatively high fees to investors on most share classes, while there are no passive options currently in the catastrophe bond space.
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