Buying opportunity for CATCo Reinsurance Opportunities

We all know that we should aim for a well-diversified portfolio, but that is easier said than done given the high correlations between most of the main asset classes. The tendency for different securities to move in unison is particularly acute during a sharp market sell-off, which is precisely when you need your more defensive holdings to increase their value.

Most investors use gold to improve their diversification and there are various alternative asset classes that are also worth considering, with one of the least correlated being catastrophe insurance bonds. These are available via the specialist investment trust CATCo Reinsurance Opportunities (LON:CAT), whose C shares trade in London under the ticker CATC.

A catastrophe or cat bond is a security issued by an insurance or reinsurance company that transfers a specified set of risks to the investors. An example would be a loss arising from a well-defined natural disaster like the earthquake that hit New Zealand in November 2016.


In most cases the insurance company will sponsor the creation of a special purpose vehicle (SPV) to issue the bond. The SPV is then responsible for holding the cash raised from the initial investors as collateral in the form of AAA-rated securities.

The interest payments on the bonds are funded by the return on the collateral and the premiums paid into the SPV by the sponsoring insurer. In the unlikely event that the sponsor fails to meet its obligations the bonds would mature early at par with no further exposure to the insured risk.

Most cat bonds have a short maturity of up to five years. If the specific catastrophe criteria set out in the bond’s prospectus is met, then some or all of the cash held in the SPV would be paid out to the insurer to cover its potential liabilities. This would mean that investors wouldn’t get all of their money back.

Attractive risk-adjusted returns

The pay-out conditions are often narrowly defined so that the simple occurrence of the named catastrophe will often fail to trigger a default. Many of the bonds have multi-event triggers that require several of the defined catastrophes to take place before any losses are incurred.

Cat bonds are generally designed to cover ‘super’ catastrophes with a low likelihood of occurrence, usually defined as having around a 1% or 1-in-100 year probability. It is these remote risks that put the biggest strain on an insurer’s balance sheet, which is why they are prepared to pay a high premium to offload them.

The final return depends on whether the insured natural disaster takes place, which means their performance is largely independent of the financial markets, hence the low correlation with other asset classes.

This allows the CATCo Reinsurance Opportunities fund to target a USD net return of LIBOR (currently 1%) plus 9% to 12% per annum over the medium term, which includes an annual dividend equal to LIBOR plus 5% of the NAV at the end of each fiscal year.

Cat bonds are floating rate securities and tend to go up when interest rates rise. The final return depends on whether the insured natural disaster takes place, which means their performance is largely independent of the financial markets, hence the low correlation with other asset classes. Investing in a diversified fund helps to limit the downside risk associated with each extreme event.

CATCo Reinsurance Opportunities

CATCo Reinsurance Opportunities was launched in December 2010 and by the end of 2016 had a net asset value of (NAV) of $463m. It has a punchy annual management charge of 1.5% and a 10% performance fee on gains in excess of LIBOR plus 7.5% subject to a high water mark.

All of its assets are invested in the Bermuda-based Markel CATCo Reinsurance Fund, which provides exposure to a diversified portfolio of catastrophe reinsurance risks spread across several different non-correlated risk categories. This helps to limit the amount of capital at risk from a single catastrophic event.


If there had been no insured losses arising in 2016 the fund would have expected to generate a net return of 16%. Some natural disasters would have resulted in an even higher return due to the impact of hedging, while the worst case single event was limited to a 10% loss and could have been triggered by a variety of occurrences including an earthquake in Australia, a windstorm in Europe and an earthquake in California.

The CATCo Reinsurance Opportunities C shares (LON:CATC) were issued in October 2015 and raised an additional $88.4m. Initially the intention was to convert these to ordinary shares in the first quarter of 2016, but the plan was delayed because of the uncertainty of the exposure of the ordinary shares to losses arising from the UK floods and US tornados that took place in December 2015. It is likely that the conversion will occur at some point during the current quarter.

CATC has traded at an average 12-month premium of 0.2%, but has recently slipped to a discount of 6.1%. This was due to a poor December when the NAV fell by 2.1% with the NAV return for the calendar year being driven down to 7.3%, which was well below the net target return of LIBOR (currently 1%) plus 9% to 12%. The shares finished 2016 slightly higher, but have fallen about 5% in the first few weeks of 2017.

The reason for the poor performance was that 2016 was the worst year for disaster claims across the industry since 2012. Events that affected the fund included a 3% hit from the Canadian wildfires; a 1% loss in relation to the damage caused by Hurricane Matthew in South Carolina in October; and an additional 1% from the New Zealand earthquake in November. There was also an energy loss in Ghana’s Jubilee oil field that cost 3.5%.

The fund is capable of delivering healthy double-digit gains with a chunky dividend, with the discount on the C shares providing a useful entry point.

Over the longer term the performance has been much better with the ordinary shares returning 75% between launch in December 2010 and the end of 2016, which is in line with the fund’s objective.

Uncorrelated sources of return like CATC offer a way to protect your portfolio against the high level of global uncertainty, especially in view of its dollar denominated exposure. The fund is capable of delivering healthy double-digit gains with a chunky dividend, with the discount on the C shares providing a useful entry point.