Catastrophe Bonds To Become More Accessible With New ETF Launch

Catastrophe bonds, a high-risk but highly rewarding investment that has outpaced returns in the high-yield debt market, are set to be more accessible to a broader range of investors. Next month, the New York Stock Exchange will begin trading an exchange-traded fund (ETF) based on a portfolio of up to 75 catastrophe bonds (cat bonds), marking the first of its kind.

King Ridge Capital Advisors Inc. will manage the ETF, which is being launched in partnership with Brookmont Capital Management LLC. Rick Pagnani, co-founder and CEO of King Ridge, emphasized that the goal is to make this niche asset class easier to understand for everyday investors. Pagnani, formerly head of the insurance-linked securities desk at Pacific Investment Management Co., explained the difficulty individual investors face when trying to diversify a cat-bond portfolio on their own, noting that the new ETF aims to lower the barriers to entry.

Cat bonds have been increasingly appealing to investors in recent years due to their impressive returns. In 2024, the Swiss Re Global Cat Bond Index surged 17%, following a record-breaking 20% increase the previous year. This far outpaced the 8% rise in Bloomberg’s high-yield US corporate bond index in 2024 and 13% in 2023.

Issued by insurers, reinsurers, and sometimes government entities, cat bonds allow these entities to transfer the financial risks of natural disasters to the capital markets. Investors in cat bonds stand to earn significant returns if the predefined catastrophic events do not occur. However, they risk substantial losses should a disaster take place.

As the effects of climate change exacerbate extreme weather events and urban expansion increases in high-risk areas, demand for cat bonds has been climbing. According to Ethan Powell, Chief Investment Officer at Brookmont, many insurance companies are retreating from high-risk areas as the cost of owning assets increases. This has spurred the need for additional capital to flow into the cat bond market to bolster financial protection against future disasters.

The market, which is primarily driven by US issuances, is currently valued at around $50 billion, with deal volumes described as “exceptional” in recent years. Experts predict that the market will grow to approximately $80 billion by the end of the decade, fueled by an ongoing surge in issuance.

Despite recent natural disasters, such as Hurricanes Helene and Milton, and fires in Los Angeles, catastrophe bondholders have largely avoided significant losses. The Swiss Re Index reported a modest 2% loss in 2022 after Hurricane Ian caused $65 billion in insured losses. Investment managers specializing in cat bonds have worked to refine their models to minimize the likelihood of triggering payout clauses.

King Ridge and Brookmont are still in the process of finalizing launch partners and are targeting $10 million to $25 million in seed capital. The ETF, which has recently met regulatory requirements, will trade on the New York Stock Exchange under the ticker symbol ILS. The fund’s investments will cover natural disasters ranging from hurricanes in Florida and earthquakes in California to typhoons in Japan and windstorms in Europe.

Despite the potential for attractive returns, cat bonds remain complex, raising concerns about their suitability for less specialized investors. In Europe, where exposure to cat bonds is available through UCITS funds, the complexity of these instruments has led to questions about investor understanding of the risks involved. Pagnani acknowledged the risks but emphasized that a diversified ETF structure can help mitigate volatility while still offering competitive returns.

Looking ahead, Bloomberg Intelligence expects the thematic fixed-income market to continue its growth. Demand for specialized products, like catastrophe bonds, is expected to rise further through 2025, as they continue to outperform traditional fixed-income investments.