April 21, 2020

No coronavirus contagion for the catastrophe bond market: Seo

John Seo, Fermat Capital Management

It’s business as usual in the catastrophe bond market despite the global crisis of the Covid-19 coronavirus outbreak, according to John Seo, Co-Founder and Managing Director of Fermat Capital Management.

Commenting in a recent communication to his investors on the coronavirus outbreak, its effects on global financial markets and whether that has affected catastrophe bonds, Seo says “catastrophe bonds generally remain unaffected.”

“In the midst of a global pandemic, investors are quite understandably asking whether the catastrophe (cat) bond / insurance-linked securities (ILS) market are caught up in the wider market contagion,” Seo explained.

Adding, “While there are bonds connected to more exotic perils – such as pandemic bonds – these are very niche and in general cat bond market conditions remain unaffected by the outbreak of Covid-19.”

Of course the World Bank issued pandemic catastrophe bonds are exposed to a loss from the ongoing coronavirus outbreak, which looks increasingly likely to cause a default and loss of principal after March 23rd.

But in the broader catastrophe bond and insurance-linked securities (ILS) market, these pandemic bonds are just one transaction among many and the majority of the outstanding market has no exposure at all to the Covid-19 virus outbreak, or to the wider financial market declines being seen in recent days.

Given catastrophe bond investors fully collateralise the largely natural catastrophe risks they invest in and that collateral is invested in about the safest assets around such as treasuries, there can be little impact to the market even from a global crisis such as coronavirus.

In his communication to investors Seo explains, “Against a market backdrop that is experiencing the most extreme turbulence since the global financial crisis in 2008, it is worth reiterating that catastrophe bonds and ILS are tied to risks that fundamentally have nothing to do with the economic cycle, interest rate movements, the political environment or currency fluctuations. Instead, the returns of these investments are largely driven by significant insurance and reinsurance loss events connected primarily to natural phenomena, such as earthquakes and hurricanes.

“A market crash cannot cause a cyclone or an earthquake to occur and while these catastrophic natural disasters do happen – and drawdowns will happen with time – when they do they are independent of the ongoing activity in the traditional financial markets.”

In fact, in times of financial market stress cat bonds as an asset class, as well as wider insurance-linked securities (ILS) and collateralised reinsurance, can offer a welcome diversifier for investors.

“ILS returns have a different set of drivers and can benefit from being fundamentally uncorrelated with the broader market, unlike other asset classes where correlations can significantly increase during times of market stress,” Seo said. “Consequently, the addition of ILS into a portfolio can deliver on the promise of non-directional strategies: the potential to instantly enhance investor portfolios by reducing volatility and providing more stability of returns.”

Adding, “We do not believe we need to alter our investment strategy or position in response to the Covid-19 outbreak. For us, this year remains business as usual.”

To read more articles like this one, visit Artemis.

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