Cat bond index tracking ETF not yet feasible: Solidum Partners

The catastrophe bond market is not ready for an exchange traded fund (ETF) that tracks an index, according to specialist Swiss insurance-linked securities (ILS) investment manager Solidum Partners AG, who say it’s not feasible at this time for such a strategy to exist, given challenges in dynamic replication of an index for the cat bond market and current market structure.

In a paper published recently, Solidum Partners lays out the reasons the catastrophe bond market may not be suited to an index-tracking cat bond ETF fund approach.

It’s important to note though, that the first US stock exchange listed cat bond ETF is set for imminent launch, the Brookmont Catastrophic Bond ETF which will be listed on the New York Stock Exchange (NYSE) within days (we understand) under a ticker symbol of ILS.

The Brookmont strategy is not attempting to track or replicate an index of the catastrophe bond market though, its latest prospectus implies, but it will be the first US listed cat bond ETF strategy.

Back to the paper published by Solidum Partners, which describes the cat bond market as lacking in liquidity, having restrictive minimum trading denominations that could affect the operations of an index-tracker cat bond ETF, highlights challenges in correcting a strategy to closely follow an index and maintain close tracking of it, points out that trading is manual and how this could lead to higher costs, that market pricing is weekly at best which means dynamic pricing would be difficult, and that there is currently no active market maker or entity warehousing risk working in the catastrophe bond sector.

Solidum Partners’ Dr. Ulrich Behm, Partner with responsibility for sales and marketing for the company and its investment strategies, explained why the company believes there won’t be a cat bond index tracker ETF anytime soon.

Behm explained, “Many investors wonder why Cat Bonds are not investible via an ETF. While the idea of gaining diversified access to the cat bond market through a low-cost, passive product may seem appealing, there are several fundamental reasons why this concept is difficult to realise in practice.

“Lack of Market Liquidity: Cat Bonds are traded over the counter with limited secondary market activity. This lack of liquidity makes it impossible to dynamically replicate an index, a core feature required for an ETF structure.

“High Trading Denominations & Manual Execution: Most Cat Bonds trade in minimum lots of USD 250k. Trading is manual and allocations are not guaranteed. This severely limits scalability, automation, and efficiency—core elements for any ETF product.

“No Natural Market Maker: ETFs require a dedicated market maker to continuously offer liquidity and pricing. In the Cat Bond space, no such function exists, making it impossible to ensure tradability or pricing transparency in a fund format.

“These structural challenges go against what makes ETFs attractive: daily liquidity, low cost, and transparency. Until these fundamental barriers are addressed, a Cat Bond ETF remains out of reach.”

Rather than replicate Solidum Partners’ paper, we felt it better to direct our readers to download a copy to read the full commentary.

As we reported recently, catastrophe bond market participants are increasingly citing the benefits of having market makers, although some question whether the market is mature and liquid enough to support them.

The coming Brookmont cat bond ETF may need market maker and liquidity provider support, so that will be interesting to watch for. While we are also hearing from companies that provide those services in other asset classes, who are increasingly intrigued by the cat bond market and its potential to become more liquid over time.

The other issues Solidum Partners highlights are all pertinent and related to the market structure we see today. Over-time, with growth, continued expansion of the investor base, and increasing participation from more investors that tend to adopt a dynamic trading mentality, that structure is likely to evolve and could become more index ETF-conducive, but how quickly is hard to say.

Whether the catastrophe bond asset class will ever be ready for a true index tracking cat bond ETF remains to be seen. But it is a topic that gets ETF providers interested and we’ve spoken with many over the years that enquire with us about the availability of indices and just how deep the market actually is, in liquidity and activity terms.

Solidum Partners highlights a number of important considerations and it’s a good paper to get market participants thinking about whether index-tracker strategies can ever be part of the cat bond asset classes future.