~ John Seo, co-founder and managing director, Fermat Capital
The catastrophe (cat) bond space is seeing unprecedented demand for capital. The abundance of quality issuance since Hurricane Ian in what can often be a restricted asset class is opening up an unexpected opportunity and therefore portfolio diversification potential.
In an environment of high inflation and volatile financial markets, investors are increasingly turning to innovative investment options to safeguard their returns and enhance portfolio diversification. One such solution is Catastrophe Bonds, commonly referred to as (cat) bonds or insurance-linked securities (ILS). At GAM Investments, we have partnered with Fermat Capital, a renowned leader in the insurance-risk industry with extensive expertise, to provide our clients with unique and specialized cat bond strategies.
Crucially for portfolio diversification, cat bonds have typically low correlation to more traditional investments, even during periods of heightened volatility."
Catastrophe bonds, also known as cat bonds, a type of insurance-linked security (ILS) are fixed income instruments issued by insurers and reinsurers to transfer to investors exposures from potentially large insured losses associated with natural catastrophes, as well as other ‘perils’ such as terrorism and cyber risk. These bonds provide a form of reinsurance so that the insurer’s liabilities are covered, and they can afford to settle in full and aid recovery. In return - investors in cat bonds get paid a fixed rate of interest – just like a regular bond. The skill is to calculate each cat bond’s true risk and identify the opportunities with the most attractive yields.
Cat bonds are well aligned with environmental, social and governance principles.
E: They are at the forefront of monitoring changes in weather extremes and their impact on economies.
S: Insurance in general is a social form of finance, applied to neutralise risk across a broader pool to reduce its impact and severity on society.
G: The cat bond market brings an unprecedented level of market transparency around pay outs for catastrophes. This allows governments to plan and budget for their response to such catastrophes.
The current market conditions have created a significant imbalance between supply of cat bonds and capital able to absorb it. So effectively coming into the second half of 2024, there is the potential for much-increased issuance volume of cat bonds, as demand for risk capital is so high.”
In a world of specialist asset classes whose alternative status has been undermined by correlations with other risk assets, cat bonds offer diversification on a fundamental level. Because their pricing is not driven by economic or corporate events, returns from cat bonds are largely independent of mainstream markets and fundamentally non-correlated with traditional asset classes.
In the 1990s the insurance markets in both Florida and California were collapsing due to earthquake risk. At that time John Seo, co-founder and managing director of Fermat Capital, was invited to set up a proprietary trading group at an investment bank focusing on a new type of product – catastrophe bonds – in response to this opportunity. John is also a member of FACI (Federal Advisory Committee on Insurance), the only ILS manager on the committee.
What I loved about the asset class is it’s mainly driven by risks from earthquakes and hurricanes. That fundamental isolation from market risks was immediately appealing to me. My father, a mathematician, gave me a tail risk pricing problem when I was about 12 years old and it has been something that has fascinated me intellectually ever since."
GAM partners with Fermat, a recognised insurance-risk industry leader and highly experienced cat bond manager, based in the US. The portfolio managers, Dr John Seo, Nelson Seo and Brett Houghton, manage assets of approximately USD 9.5 billion and have over 50 years' combined experience in ILS and cat bonds, dating back to the inception of the market in the late 1990s.
The level of experience and in-depth market knowledge is critical to Fermat's ability to identify the true risk of each bond, as well as granting them ready access to new issuances.
Over time, the team have demonstrated their expertise by actively trading billions of dollars in catastrophe bonds through a series of large insurance industry events and natural catastrophes, while providing stable returns for clients and maintaining high levels of liquidity.
Its not credit risk, it's actually event risk. Institutional Investors prefer a specialist, because they want somebody handling this that has deeper knowledge about the risk.”
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