Industry loss catastrophe bonds show significant relative value: Twelve Capital

Since spread widening has been found to be greater with indexed or industry loss-triggered catastrophe bonds, compared to indemnity agreements, investment manager Twelve Capital says they have value relatively large and therefore advises overweighting the index-triggered cat bond category.

Twelve Capitals LogoTwelve Capital, the Zurich-based investment manager specializing in insurance securities (ILS), insurance and reinsurance-linked investments, explained in a recent report that widening spreads have further affected the sector loss index trigger catastrophe bonds as indemnity agreements.

As a result, index-triggered catastrophic bonds are viewed as a buy-and-hold opportunity at a good price at the moment.

Florian Steiger, Head of Cat Bonds at Twelve Capital, explained: “Observation shows that indexed Cat Bonds have generally outperformed indemnity bonds over the past few years, but the volatility around Hurricane Ian has resulted in a more complex picture with greater spread widening. pronounced in indexed Cat Bonds compared to compensation operations.

“Given the current spread dislocation between indexed trades and compensation trades, Twelve Capital believes that significant relative value can be achieved by overweighting indexed trades.”

Interestingly, Twelve Capital notes that after Hurricane Ian, indemnity cat bonds had the strongest recovery in value, while indexed cat bonds remained depressed.

However, “The main cause of this lack of recovery is a substantial widening of spreads in indexed Cat.
Significantly larger obligations than can be seen in the compensation space,” said Twelve Capital.

Twelve Capital’s analysis shows that sector index trigger cat bonds have seen their spreads widen more than indemnity cat bonds, leading to a disparity (see below).


“Assuming an average credit spread duration of around two years, this would translate to a price decline of around -8% for indemnity Cat Bonds, compared to -13% for indexed transactions. Of course, any fund overweight in these indexed trades would therefore appear to underperform relative to benchmarks or its competitors,” the ILS manager explained.

Going on to say that “At the time of writing, Indexed Cat Bonds now feature significantly wider spreads than Indemnity trades. While ultimately the spread is a reflection of a market price which itself is a function of supply and demand, there are several possible reasons why indexers have higher spreads.

These include the risk levels of the cat bonds in question, with industry loss-trigger bonds often having higher expected losses, as well as the types of perils covered, with index trading largely focused on US United, as well as the fact that industry loss trigger bonds are more generally offering retrocession than primary reinsurance.

The current spread differential gives Twelve Capital confidence in holding more index or industrial bond instruments with a loss trigger.

The ILS manager said this dislocation between indexed and indemnity cat bond trade spreads provides an opportunity to overweight the index and the industry loss side of the cat cat bond market, in order to generate better portfolio returns.

“In most cases, these trades have less modeling risk and are more transparent during and after an event, which also translates into better secondary market liquidity,” Twelve Capital explained.

But cautioned that “of course, such positioning requires an investor’s willingness to accept the fact that indexed trades tend to have higher correlation, especially during severe extreme events.”

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