Stormy outlook: Hurricane Beryl caused destruction in Vermont last month. After more than 18 months of uninterrupted gains, the cat bond market was hit by a sell-off in the second quarter. — AP
LONDON: Fermat Capital Management, one of the world’s biggest investors in catastrophe bonds (cat bonds), says anxiety about this year’s hurricane season has already left a meaningful dent on returns.
“Returns in May were low and even negative for a lot of funds,” Brett Houghton, managing director at Fermat, said in an interview.
“Widespread fears about a particularly severe hurricane season meant there was a lot of selling pressure in the secondary market.”
The hedge fund manager, who helps oversee about US$9.5bil in assets, said Fermat’s returns for the first six months of the year were “in line” with the 5.8% advance of the Swiss Re Global Cat Bond Performance Index.
That’s roughly half the index’s 10.5% return during the same period last year.
After more than 18 months of uninterrupted gains, the cat bond market was hit by a sell-off in the second quarter (2Q) as investors reacted to meteorologists predicting one of the most active hurricane seasons in recent memory.
In May, the Swiss Re index dipped about 0.5%, marking its first monthly decline since Hurricane Ian made landfall in September 2022.
For now, though, cat bond investors have been spared large losses.
Hurricane Beryl, which ripped through the Caribbean and into Texas last month, didn’t reach the precise levels of air pressure that would have triggered payment clauses and required investors to help cover losses.
Cat bonds are issued by insurers, reinsurers and governments who want an additional layer of coverage for extreme weather events such as once-in-a-generation hurricanes.
Investors face potentially substantial losses if a bond is triggered, but can gene-rate market-beating returns if a predefined catastrophe doesn’t occur.
Cat bonds underpinned the best hedge-fund strategy of 2023, with insurance-linked securities (ILS) overall delivering more than 14% on an annualised basis, based on data provided by Preqin for the first nine months of last year.
As a strategy, ILS has slipped considerably in the rankings, with Preqin now putting it at eighth place in the 12-month period ended June 30.
That said, cumulative returns tied to ILS were still 12% in that time frame.
The best hedge fund strategy – called “opportunistic” – delivered 19%, Preqin reported.
The market for cat bonds “is still relatively firm and still offers attractive returns,” said Toby Pughe, a London-based analyst at Tenax Capital.
The asset manager’s euro-denominated UCITS cat bond fund returned about 4% in the first half (1H), he said.
The securities have started to attract more mainstream investors, drawn by the possibility of hefty returns that aren’t correlated with the wider market.
It’s a development that’s starting to affect price dynamics.
In the 1Q, there was “an overzealous bid for bonds,” said Jeffrey Davis, partner and portfolio manager at Elementum Advisors, a Chicago-based investor.
“This bid then became the main detractor of 2Q performance as demand abruptly reversed course.”
The supply of the bonds is up, with issuers seeking additional coverage. That’s as regulators warn that the insurance sector won’t be able to cover the losses ahead without turning to capital markets.
Sophie Ware, a managing director at Neuberger Berman, says primary issuance of cat bonds has already topped US$12bil this year, making it “extremely likely” it be a “record-breaking year.”
The additional supply “has also resulted in a deeper market with more active secondary market trading in 2024,” she said.
Trading in the secondary market for cat bonds rose 75% to US$2.8bil in the 1H from a year earlier, according to estimates provided by Elementum.
Investors are still waiting to see how the 2024 hurricane season develops, with peak activity expected between mid-August and mid-October, according to the US National Hurricane Centre.
If a major storm makes landfall in a densely populated area, it could lead to price volatility and wider spreads.
Pughe of Tenax notes that it’s normal to see some tightening in the cat bond market when hurricane season gets underway. But there’s “no room for complacency,” he said.
And Houghton says Fermat is “not taking any comfort” just because Beryl didn’t trigger losses.
“There’s a lot more of the season to come,” he said. — Bloomberg
