The asset class of insurance-linked securities is increasingly gaining the interest of institutional investors. This is mainly because it is almost uncorrelated with other asset classes and therefore contributes positively to the diversification of the portfolio without missing a yield.

Catastrophe bonds or “CAT bonds” can be compared with a traditional reinsurance contract. Mostly events such as earthquakes, hurricanes, tsunamis are insured with the bond. So if a certain predefined event – like an earthquake in Japan or a hurricane in Florida – occurs exceeding a certain magnitude the reinsurance enters and pays the insurance out of the money invested in the CAT Bond. This is mostly with events that have a probability of occurring once every 50 to 100 years. Catastrophe bonds are certainly very predictable. Reinsurers try to cover the amount of expected losses plus a buffer for insurance premiums.

An investment in a CAT Bond may result in a total loss. Therefore, a Cat Bond Fund invests in many different disasters in order to reduce the impact of individual events (diversification). If there were to be a very large number of simultaneous catastrophes on earth, then there is a high chance that the investor would care more about the actual problems in the real world rather than his small investment in this asset class.

Yields of CAT bonds depend on two factors: the coupon and the price movement on the secondary market. The coupon rate is fixed, the price movement is tied to the nature of the risk and is often seasonal (eg hurricane season, El Niño, etc.).

A passive index for cat bonds only exists from 2002. However this index generates a high rate of return. This is not achievable in investment products for retail customers. Therefore, in the Asset Allocation Analyzer, an investment fund (in euros) and open since 2001 to investors with only small amounts to invest is used. Prior to this, this asset class was not available. For fair comparison with the Asset Allocation Analyzer, the time axis should be shortened manually to 2001.

Leave a Reply