December 8, 2023

A new study from Plenum Investments shows that while cat bond funds may have similar return-expected metrics, the tail risk inherent in cat bond fund strategies can be “substantially different” depending on the structure of the underlying portfolio.

plenary investment logoPlenum Investments, a Zurich-based investment manager specializing in catastrophe bonds and insurance-linked securities (ILS), has released a new market study looking at the composition of UCITS catastrophe bond funds by the end of 2022.

The research seeks to build on a series of initiatives that Plenum Investments has invested in over the past year or so, seeking to increase transparency in the catastrophe bond market.

These include the launch of a suite of UCITS catastrophe bond fund indices, providing a new benchmark for the industry and its investors.

Plenum’s latest research on UCITS catastrophe bond funds looks at the risk-return positioning of the strategies and uses a unified strategy to make them more comparable.

Again, it shows that there are differences in how funds diversify and the exposures they take on, while also showing differences in tail exposures between them.

“Expected losses are positively correlated with ROI prospects,” Plenum explained. “But there can be huge differences in tail risk among funds with similar return expectations.”

Plenum added, “This shows that some funds manage risk more effectively than others, as evidenced by the VaR ratio (99%) and the discount rate.”

On average, UCITS catastrophe bond fund populations account for more than 75% of U.S. wind and earthquake risk in terms of contribution to expected losses, while European wind and earthquake risk accounts for only 5.64% on average and Japan risk accounts for 6.03% on average .

The concentration of wind power and earthquakes in the United States varies. The expected loss contribution rate of wind power in the United States is the highest at 63.33% and the lowest is 44.94%. The highest concentration of earthquake risk in the United States is 26.71% and the lowest is 15.74%.

As you can imagine, while risks in the U.S. account for the majority of expected losses, there are other risks outside of the main classification groups.

Other risk categories accounted for nearly 13% of the catastrophe bond fund group’s risk concentration on average, but there was significant variation across the group, ranging from as low as 6.24% to as high as 26.10%.

Plenum said its research showed that “funds with relatively large exposure to U.S. wind power are subject to higher tail risk.”

“A fund’s tail risk is related to its position profile and the fund’s diversification. In particular, the above-average allocation of US wind exposure illustrates the nature of this high tail risk,” Plenum continued.

The investment manager also noted uncertainty in the results due to reporting timing, the maturity and timing of cat bond fund holdings, and the fact that some funds contain more private equity assets than others.

Greater standardization in reporting and transparency would help, allowing cat bond investors to better compare strategies, Plenum said.

states, “Our research also aims to encourage the CAT bond fund industry to clearly identify assets in their annual reports. We also recommend establishing expected loss and VaR (99%) as standard risk metrics for CAT bond funds and requiring funds to disclose the calculated basis (modeling software) or point to limited comparability.”

Plenum Investments invites interested parties to request a copy of the full research report by emailing the manager at: (email protected)

Analyze this interactive chart for the UCITS Catastrophe Bond Fund Index.

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