Catastrophe Bonds 🌩️

Author

Owen
February 15, 2025

In partnership with

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  • Egg prices are going mental 🍳

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The Crux 🔴

I recently bumped into this Bloomberg article from last year about a niche hedge fund founded by a biophysicist. The fund, called Fermat, invests in a lesser-known segment of the market; catastrophe bonds, and emerged as one of the most profitable hedge fund strategies last year.

Scientist + hedge fund + uncorrelated investment.

I’m in.

🐰🕳️⌚

What 🧐

Cat bonds are debt instruments that transfer catastrophe-related risks from insurers or governments to investors. They are typically used by insurance companies, reinsurers, and governments to protect against large-scale natural disasters, such as hurricanes, earthquakes, or floods.

The market for such products emerged in the 1990s after Hurricane Andrew and the Northridge Earthquake strained reinsurance markets in Florida and California.

The issuer, usually an insurance company, establishes a special purpose insurer (SPI) to issue the bonds, which typically have a maturity of 3 to 5 years. Unlike corporate bonds, where proceeds go directly to a company's balance sheet, funds from cat bonds are fully collateralized and held in highly secure assets like U.S. Treasuries.

Investors earn regular coupon payments, often at higher yields than traditional bonds, in return for taking on catastrophe risk. If no qualifying disaster occurs, they recover their principal at maturity. However, if a predefined event—such as a hurricane of a certain intensity—triggers the bond, a portion or all of the collateral is released to the sponsor to help cover losses.

One key feature of Cat bonds is trigger types, which determine when investor funds are transferred to the issuer.

  1. Indemnity

    Pays out based on the actual losses of the insurer, ensuring a direct match to their financial impact but requiring detailed claims assessment.

  2. Industry Loss

    Activates when total insured losses across the industry exceed a set threshold, relying on third-party data rather than the issuer’s specific losses.

  3. Parametric

    Payout depends on measurable event characteristics (e.g., earthquake magnitude, wind speed), allowing for faster settlements but not always reflecting actual financial losses.

  4. Modelled Loss

    Uses catastrophe models to estimate losses based on event parameters and insurer exposure, balancing speed with a data-driven approach.

Attractiveness ✨

  1. Attractive returns: Cat bonds typically offer higher yields than traditional fixed-income. In 2023, the Swiss Re Global Cat Bond Total Return Index posted a 19.7% return, its best performance since 2002.

  2. Rising interest rates benefit: Unlike traditional bonds, cat bonds are structured with floating-rate coupons, meaning their yields adjust with rising interest rates. making them more attractive in high interest-rate environments.

  3. Diversification: Cat bonds have low correlation with equities and traditional fixed-income, providing strong diversification benefits. Performance is driven by catastrophe risks rather than macroeconomic factors, making them a unique hedge against market volatility.

Risks ⛔

  1. Event risk: The biggest concern is the catastrophic event taking place and triggering the bond, leading to a partial or total loss of your investment. With climate change increasing the frequency and severity of natural disasters, this risk is becoming even more significant.

  2. Illiquidity: Unlike traditional bonds, cat bonds trade in a smaller, less liquid market, making it challenging to sell your holdings quickly, especially after a major disaster.

  3. Counterparty risk: If a large-scale catastrophe occurs, the insurer responsible for the bond might struggle to meet its financial obligations or even default.

Investment Implications 🤑

Retail investors looking to pile into the cat bond market might end up disappointed, as there are limited options available.

A handful of mutual funds, mainly Schroders and GAM can offer cat bond exposure.

No ETFs are currently available although Brookmont is slated to launch one soon, with a ticker symbol…

drumroll

ROAR.

Dig Deeper ⛏️

P.S. Liking this issue? Forward to a friend 🧑‍🤝‍🧑

Headhunted 🦅

Recently funded private companies need talent! Scout jobs at recently funded European startups, ahead of your competition. 💪

  1. Riot 🇫🇷 - The cybersecurity firm has raised a €28.9m Series B. Hiring in tech, sales and ops. (link)

  2. Ionate 🇬🇧 - The smart grid startup has closed a €16.3m Series A round. Engineering roles open. (link)

  3. Jentis 🇦🇹 - The web data capture company has closed a €11m Series A. Sales & compliance roles open. (link)

  4. Enduro Genetics 🇩🇰 - The synbio startup has raised €12m in a Series A round. Research roles available (link)

  5. Saeki 🇨🇭 - The manufacturing automation company raised over $6.5m in a new funding round. Hiring a CAD programmer (link)

Interestingness📔 

  • The Secretive Hedge Fund Rewriting the Rules of $4.5 Trillion Industry (link)

  • Tuttle Capital files for ‘alien tech’ ETF (link)

  • US egg prices hit a record high of $4.95 due to bird flu (link)

  • Apollo Plans to Build the First Marketplace for Private Credit (link)

  • The Drug Industry Is Having Its Own DeepSeek Moment (link)

📚 New to investing? Grab a PDF copy of my ebook here.

As always, the financial disclaimer!

This is not investment advice. I am not a financial advisor. Make sure to conduct your thorough research before purchasing or selling financial products.