Ben Mohr, CFA
Director of Fixed Income
Institutional investors are constantly searching for additional asset classes that may help diversify a portfolio and enhance returns. Catastrophe (“cat”) bonds may be such an asset class that could help diversify a portfolio’s interest rate, credit/equity and currency risk by providing non-correlating natural event risk. Cat bonds are typically issued by insurance companies that pool property and casualty policies. They pay coupons to the bondholder using the policy premiums received. When a natural event occurs — such as a hurricane or an earthquake — part of the principal of a cat bond may be used to pay the insurance claims on the pool of policies. In other words, the investor is paid to assume a part of the risk associated with natural events. Historically, cat bonds average 5% to 10% return annually.
This paper discusses the benefits of cat bonds and the mechanics of how they work, along with their market size. The characteristics of cat bonds and the types of cat bond strategies will also be examined. The paper will provide details about cat bonds’ merits and risks to help investors make informed decisions about whether to consider this asset class. It will conclude with a discussion of recent and long-term performance.
The opinions expressed herein are those of Marquette Associates, Inc. (“Marquette”), and are subject to change without notice. This material is not financial advice or an offer to purchase or sell any product. Marquette reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.
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