Catastrophe bonds (cat bonds) have been consistently outperforming high-yield debt markets, and now, these high-return investments are about to be more accessible to a wider range of investors.
In a significant development, an exchange-traded fund (ETF) based on a diversified portfolio of up to 75 of the 250 cat bonds currently outstanding will start trading on the New York Stock Exchange next month. This marks the first-ever ETF focused on catastrophe bonds, designed to democratise access to this niche investment sector.
Rick Pagnani, CEO and co-founder of King Ridge Capital Advisors Inc., the firm managing the ETF, explained that the complexity of building a diversified catastrophe-bond portfolio can be challenging for individual investors. By packaging cat bonds into an ETF, Pagnani hopes to lower the barriers to entry and offer more investors the opportunity to participate in this high-return asset class.
Cat bonds have been attracting significant attention in recent years, as they have far exceeded the returns seen in other high-risk fixed-income markets. For instance, the Swiss Re Global Cat Bond Index rose 17% in 2024, following a record 20% gain in 2023. In comparison, a Bloomberg gauge of high-yield US corporate bonds increased by just 8% in 2024 and 13% in 2023.
These bonds are issued by insurers, reinsurers, and government entities to transfer the risks associated with natural disasters to the capital markets. Investors who hold cat bonds stand to make substantial gains if the pre-defined catastrophe does not occur, but they also face the potential of large losses if it does.
The market for cat bonds has grown substantially, driven by increasing demand due to intensifying extreme weather events linked to climate change and urbanisation in disaster-prone areas. As Ethan Powell, chief investment officer at Brookmont Capital Management, noted, many insurance companies are retreating from high-risk areas, creating a greater need for capital to flow into catastrophe bonds to buffer against future losses.
With a current market value of roughly $50 billion, the cat bond market is experiencing strong deal volumes. Experts expect the market to grow to about $80 billion by the end of the decade, as more capital is needed to manage the growing risk of natural disasters.
Despite recent natural disasters, such as Hurricanes Helene and Milton and the Los Angeles wildfires, cat bondholders have largely avoided significant losses. The biggest hit to returns occurred in September 2022, when Hurricane Ian caused $65 billion in insured losses. However, losses for cat bond investors were limited to around 2%, according to the Swiss Re index.
The upcoming ETF, which is still finalising launch partners, will cover a wide range of risks, from Florida hurricanes and California earthquakes to typhoons in Japan and windstorms in Europe. The ETF’s diversified approach offers the potential for “uncorrelated income” and “resilience in volatile markets,” providing investors with an opportunity to diversify away from traditional stock and bond markets.
While cat bonds remain a complex asset class, this new ETF could make them more accessible to non-specialist investors. However, experts caution that investing in cat bonds is not without risk. Nevertheless, with a diversified approach, the ETF is designed to reduce volatility while potentially increasing returns for those willing to navigate this niche but lucrative market.
