Steady as she goes

Last month, billionaire investor, Carl Icahn, noted that "unfortunately... the meltdown in high yield is just beginning". While junk bond yields have soared, reinsurance rates have continued to decline. These two opposing forces could explain the remarkably steady return profile of the primary catastrophe bond market.

The chart below shows the risk/return profile of the cat bond market for the last four years. The best fit lines for 2014 and 2015 are on top of each other (the lowest line).

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For some investors, collateralised reinsurance is a substitute investment for cat bonds, while other investors can move move capital freely between junk bonds and cat bonds. This causes the price per unit risk in the cat bond market to be related to the returns in both the reinsurance market and the high yield debt market. The last six months has seen the risk premia in these two markets move in opposite directions.

This chart shows the implied spread for 2% risk in the cat bond market over time. It looks at the trailing twelve months of issuance and is offset by six months to the centre analysis period. The Merrill Lynch US high yield option adjusted spread shows the recent jump in junk bond yields.

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The final chart shows the outstanding cat bond market size by principal, total annual coupon payments and total annual coupon payments less expected losses.

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Posted: Monday, January 4th, 2016