Cat bond market dynamics sustain attractive investment opportunity: Frontier

While catastrophe bond spreads have tightened since their high-point reached in the wake of hurricane Ian, the market dynamics currently being seen are sustaining an attractive opportunity for investors, according to Isabella Milazzo of Frontier Advisors.

Frontier Advisors is an Australian independent investment consultant with experience advising regional institutional investors that allocate to the insurance-linked securities (ILS) asset class.

In a recent paper, Isabella Milazzo, a Consultant in the Alternatives Research Team at Frontier Advisors, explained that the catastrophe bond investment opportunity remains very attractive at this time.

Milazzo said that, despite dipping back in the last year, catastrophe bond spreads “remain at their highest sustained level since 2012” and that “current dynamics in the cat bond market are sustaining an attractive investment opportunity.”

Milazzo highlights three key factors, first of which is the continued high demand for cat bond protection being shown by sponsors.

With reinsurance capacity remaining constrained, sponsors are looking to manage risk against a backdrop of exposure growth due to increasing rates and inflation, and rating agency focus on their balance-sheet adequacy.

From the investor side, a second key driver is the sustained increase in interest rates, which has fed through into some of the highest collateral returns seen in years, supporting the overall total return of the cat bond market.

Finally, the “market-wide improvements” in structural terms and conditions of reinsurance coverage, that have also been adopted by the cat bond market, have made for a more “investor friendly” asset, Milazzo explained.

These include, higher attachment points, a shift in the market towards occurrence, non-cascading covers, and structural features that help to limit the risk of trapped capital.

Because of this, the current market environment and level of spreads continue to present an attractive investment opportunity.

In addition, while investment conditions still look attractive, the key selling point of investments in insurance-linked securities (ILS), their relatively uncorrelated and diversifying nature as assets, still holds true, Milazzo said.

“ILS are structurally uncorrelated to financial markets and macroeconomic factors and therefore are an attractive tool for diversification,” Milazzo explained. Adding that, “Frontier believes an appropriate combination of alternative assets (including ILS) with traditional assets will help to deliver more consistent returns and provide for an investment portfolio that is more resilient to prolonged drawdowns.”

Milazzo also said that Frontier Advisors continues to prefer ILS assets linked to natural catastrophe risks, due to their low correlation to financial markets, as well as the maturity of the industry, use of well-established but continually evolving models, insurance sector expertise and the seasonality inherent within them.