Cat Bond prices have reduced up to three percent compared to their traditional post-hurricane season pattern, mainly due to selling from ILS funds looking to generate liquidity before the upcoming January renewals.
This results in an attractive entry opportunity for investors looking to invest in this asset class or to top up existing positions.
All Cat Bond products managed by Twelve Capital are predominantly invested in the liquid part of the ILS universe (i.e. Cat Bonds), aim to be well diversified and have a moderate risk profile targeting mid- to high single digit returns in USD.
ILS market situation
Over the preceding two months, selling pressure on Cat Bonds was observed. Unusually long bid lists by apparently larger ILS managers were driving down valuations, which is in stark contrast to previous years’ post season trading and which cannot be explained by the usual portfolio rebalancing of ILS players in anticipation of the upcoming renewals. Twelve Capital believes that this selling pressure was induced by the fact that, with 2018 we are facing the second “frequency year” in a row, i.e. a year of several medium sized events, which cumulatively have a detrimental effect on collateralised Private ILS transactions. We can only guess as to the extent of the collateral amounts blocked but it would appear sensible to assume that there should be a significant volume of lower attaching transactions trapped by this year’s events. Adding to the mix is also the potential for disappointing performance in higher risk strategies. Twelve Capital also believes that the current selling pressure may also come from redemptions.
Cat Bond prices
In comparison to previous years, the Cat Bond market has failed to deliver its typical strong seasonality pattern, as outlined in figure 1. Twelve Capital estimates that, on average, Cat Bond prices are around 2-3 percentage points below their expected value at this point in the calendar year. Some individual bonds have traded in secondary markets at even more attractive discounts.
Investors able to deploy cash in the current environment may optimise this situation and gain an entry into the asset class at what Twelve believes to be an attractive entry point. There is healthy supply of Cat Bonds in the secondary market, allowing the prompt deployment of cash into a variety of perils.
Twelve believes that the current selling pressure on Cat Bonds should dissipate once most reinsurance capacity has been placed in January. Equally, volatility could also further intensify in the near term. Given that Cat Bonds are typically only three-year structures, the current mispricing should be corrected once more investors have reacted to this current investment opportunity.