Catastrophe bonds gain popularity among retail investors

Catastrophe bonds, once reserved for hedge funds and alternative asset managers, are increasingly attracting retail investors. These high-risk securities have gained popularity after delivering the best performance among hedge fund strategies in 2023, according to Bloomberg.

Under Europe’s UCITS label, designed to safeguard retail investors, catastrophe-bond funds have seen their assets under management rise by 12% this year, reaching a record $12 billion, according to Kepler Partners. UCITS cat bonds now comprise approximately a quarter of the total market for such debt.

Matthew Barrett, a partner at Kepler, noted in a Bloomberg report: “We’ve seen a broadening of the UCITS market for cat bonds since late 2022. It’s a very rich period for the asset class.”

Catastrophe bonds are typically issued by insurers seeking to transfer risk to the capital markets. Factors such as climate change, population density, and inflation have contributed to increased issuance. Investors in these bonds can achieve superior returns if no specified catastrophe occurs, but they risk substantial losses if one does.

Issuance of catastrophe bonds is set to hit a record high this year, coinciding with forecasts of an active hurricane season likely to cause significant property damage.

The appeal of UCITS

UCITS, or Undertakings for Collective Investment in Transferable Securities, are regulated mutual funds designed to ensure safety for retail investors. They represent the largest retail investment sector in the EU.

Several funds have experienced significant growth, Bloomberg noted. Schroders Plc’s UCITS cat-bond fund increased by $390 million this year, while Leadenhall Capital Partners’ UCITS cat-bond fund tripled its assets to nearly $900 million and Amundi SA’s US-focused cat-bond mutual fund has accumulated about $328 million in assets.

Amundi expressed optimism in a May report, stating: “We believe the combination of continued elevated pricing, combined with the ongoing demand for reinsurance, may present an attractive investment opportunity throughout the remainder of 2024 and into 2025.”

Retail investors’ role

While asset managers clarify they are not directly marketing cat-bond funds to retail investors, the inclusion of these bonds in UCITS expands access to this asset class.

High returns have sparked interest among banks, family offices, and pension funds, according to Dirk Schmelzer, senior fund manager for insurance-linked securities at Plenum Investments AG. “We’re not actively marketing to the retail space,” he said, noting banks hold cat-bond funds in discretionary accounts, indirectly exposing retail investors.

Regulators are monitoring this trend closely. The European Securities and Markets Authority (ESMA) initiated a call for evidence regarding the implications of including cat bonds and other high-risk securities in UCITS, evaluating whether regulations are being appropriately applied.

Despite the influx of new investors, industry insiders maintain the market is still primarily dominated by seasoned professionals. “It’s mainly been pension fund money over the last 10 to 15 years,” Lorenzo Volpi, deputy chief executive at Leadenhall, told Bloomberg. “Now we’re seeing more multi-asset funds, family offices, and even life insurers showing interest.”

Market dynamics and preparation

Daniel Ineichen, co-head of insurance-linked securities at Schroders Capital, highlighted that professional investors, who often prefer regulated UCITS funds, predominantly control the market.

“There’s interest from Europe, Asia, and Australia,” Ineichen added, noting that cat bonds currently offer “a spread of about 9% above the risk-free rate” of US Treasuries, a significant yield gap compared to regular corporate bonds.

As hurricane season approaches, asset managers like Schroders are adjusting strategies, increasing cash reserves to prepare for potential challenges.

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