“Cat Bonds” offer yield and decorrelation from systemic risk

Markets celebrated the US-China tariff deal, erasing losses since the beginning of the year, and the dollar recovered ground against major currencies. But news from the trade war front does not change the scenario of uncertainty, even though Treasury Secretary Bessent says it is a deliberate uncertainty, a “strategic uncertainty” that Trump, “deal man,” uses as leverage in negotiations.

In reality, Trump uses an old marketing trick, that of communicating a price and then, with a series of arguments, bringing it down to lower values. The anchoring bias is used in door-to-door sales as well as in the launch of innovative products, but the doubt that such marketing practices are also suitable for managing the largest economy in the world is legitimate. Moody's seems to respond indirectly by lowering the credit rating of federal debt, the "big and beautiful law" under consideration in Congress will most likely worsen public finances.

The uncertainty of companies, which in such a context are unable to make realistic business plans, is the uncertainty of investors, even the most prudent ones oriented towards a preference for bonds. In this market phase, interest in “Cat Bonds”, the “catastrophe” bonds issued by insurance companies, is growing, especially by institutional investors and sophisticated investors: if the spirit of the times is that of uncertainty, this type of instrument offers yield and decorrelation.

There are at least three reasons that arouse the interest of institutional investors towards cat bonds: they offer interest rates often above 7–8%, they are bonds linked to physical events, not to market dynamics, they offer higher risk premiums with a non-systemic but concentrated and insurable risk, the natural event. In a phase of monetary normalization, they are a source of competitive yield.

Several phenomena are occurring simultaneously that support the “cat” bond market: urbanization and population in areas subject to natural disasters are growing, the value of real estate is increasing, and therefore insured values ​​are growing, which in turn are increasing the demand for risk transfer by insurance and reinsurance companies.

The volumes of new issues are also growing, a phenomenon that confirms the increasingly important role of Cat Bonds in risk transfer markets.

The subscriber of the catastrophe bond knows that the high yield compensates for the possibility that the occurrence of a given extreme weather event will lead to significant losses of capital. It is not a suitable instrument for those seeking absolute stability because the stability of returns over time can be abruptly interrupted by a natural disaster. But for institutional investors, family offices or sophisticated investors with a medium-long time horizon and adequate risk tolerance, it is an efficient form of diversification.

Cat bonds tell a story of innovation and adaptation. In an era where risks seem to multiply, it is not paradoxical that extreme risk, if understood and isolated, can become an element of medium-long term stability in the most advanced portfolios.