Catastrophe bonds, whose returns have consistently trounced those of high-yield debt markets in recent years, are about to become accessible to a wider group of investors.
An exchange-traded fund based on a portfolio of as many as 75 of the 250 so-called cat bonds outstanding is due to start trading on the New York Stock Exchange next month, marking a world first.
"It's a very nuanced asset class and our goal is to demystify it," Rick Pagnani, co-founder and chief executive of King Ridge Capital Advisors, which will manage the ETF, said in an interview. The fund will be overseen by Texas-based Brookmont Capital Management.
Pagnani, who until last year was running the insurance-linked securities desk at Pacific Investment Management, said it's "challenging to build a diversified catastrophe-bond portfolio for a typical investor on their own." By packaging cat bonds into an ETF, "we aim to lower some of the barriers to entry," he said.
As an investment, cat bonds have drawn attention in recent years after far exceeding returns on other high-risk fixed-income markets. The Swiss Re Global Cat Bond Index rose 17% in 2024, following a record 20% gain the year earlier. A Bloomberg gauge of high-yield U.S. corporate bonds increased 8% last year and 13% in 2023.
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Insurers, reinsurers and some government entities issue cat bonds in order to transfer risks associated with natural disasters to the capital markets. Investors who own the bonds can make hefty gains if a predefined catastrophe doesn't occur, but also face potentially large losses if it does.
Against a backdrop of intensifying extreme weather events fueled by climate change and the spread of urbanization in areas prone to natural disasters, demand for cat bonds is climbing fast.
"A lot of insurance companies are leaving high-peril areas as the risk of owning hard assets increases," said Ethan Powell, Brookmont's chief investment officer. So "more capital needs to flow" into cat bonds to provide an additional buffer against future losses, he said.
The market, which is dominated by U.S. issuance, is currently valued at roughly $50 billion. Deal volumes have been "exceptional" in recent years, according to industry specialist Artemis. On Tuesday, Elementum Advisors, an alternative investment manager specialized in cat bonds, said it's just launched a higher-yield fund to add to its existing portfolio of similar products. The new fund targets U.S. wind events and is "aimed at capitalizing on the cat bond market's robust growth and continued concentration in US-focused perils," Elementum said.
Pagnani said the pipeline still looks "rich and continues to build," which he expects to help drive the market to about $80 billion by the end of the decade.
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Catastrophe bondholders have so far managed to avoid major losses despite the devastation caused by recent natural disasters, including Hurricanes Helene and Milton, as well as the fires in Los Angeles. Asset managers that specialize in the bonds continue to calibrate their investment models to reduce the probability of payment clauses being triggered.
The last time investors saw a meaningful dent in their returns was back in September 2022, after Hurricane Ian ripped through Florida, leading to about $65 billion of insured losses. Cat-bond losses that year were limited to about 2%, according to the Swiss Re index.
Brookmont and King Ridge are still in the process of finalizing launch partners, and are looking to raise $10 million to $25 million in seed capital, Pagnani said. The ETF recently met regulatory requirements and will trade on the New York Stock Exchange under the symbol ILS, he said.
The fund will cover perils ranging from Florida hurricanes and California earthquakes to Japan typhoons and European windstorms, according to the prospectus filed with the Securities and Exchange Commission. Because cat bonds tend not to move in lockstep with stock and bond markets, the ETF will offer "uncorrelated income" as well as "resilience in volatile markets," Brookmont said in an email.
Cat bonds' highly complex structure has raised questions as to their suitability for non-specialist investors. In Europe, where investors can gain exposure to cat bonds through UCITS funds, the instruments are listed as securities whose structure makes them difficult for a client to understand the risks involved.
Investing in cat bonds "isn't without risk," Pagnani said. But with a diversified ETF, "you can dampen volatility while increasing returns."
