The first exchange-traded fund (ETF) offering cat bonds will attract new investors to the asset class and support future ILS market growth, portfolio manager Ethan Powell, principal and CIO of Texas-based Brookmont Capital, has told Insurance Insider ILS.
The ETF will be targeting a broad base of investors but will be marketed as a “quasi-institutional product”, said Powell.
The firm has not currently confirmed the size of seed funding that the fund will have. Powell said he has been receiving incoming enquiries, including from smaller institutions that like the ILS asset class but do not want to invest directly into cat bonds.
“It will bring a different set of investors to the asset class and will grow the asset class,” he said.
Cat bond investing is normally limited to qualified institutional buyers (QIBs), however in the case of the cat bond ETF, it will be open to all investors.
“Having ETFs composed of SEC registered 144a bonds is common,” Powell noted.
The investor base that Brookmont envisages for the fund includes hedge funds, multi-strat managers, fixed income strategies, investment managers already buying positions in individual cat bonds and funds that may have previously exited but remain interested in the asset class.
The break-even threshold for the fund to turn a profit for Brookmont is $30m-$50mn, but as an ETF it will be continuously offered with no target size at which it will close.
The fund’s ultimate size will reflect constraints on availability more than on the supply side, Powell said.
“At what point does it get too large? We think the asset class is going to gain momentum, and the size of the available universe will grow faster,” he said.
Institutional investors value daily liquidity
With ETFs aiming to provide an index-like return, Powell is looking to the Swiss Re Global Cat Bond Index as the benchmark to track.
“We are not purporting to beat the Swiss Re index, we are looking to mirror the performance of the broader market,” Powell said.
“We are offering investors exposure to the asset class but are not taking outsized bets,” he added.
The fund’s fee structure will comprise a 1% management fee, and a charge of around 50 basis points (bps) to cover operational costs, with an overall cap at 2%.
The firm is closing in on a decision about which ILS manager to appoint as its sub-advisor, as it weighs up the pros and cons of potential partners.
Powell noted that some cat bond managers had expressed concerns that a cat bond ETF might cannibalise their existing cat bond strategies. However, he believed a more expansive approach by ILS managers would ultimately serve to enable market growth, by fuelling liquidity and supporting new issuance.
Cat bonds have “multiple beneficial characteristics” that recommend them to the ETF format, the PM added, particularly secondary market trading which he envisages will support a daily valuation of the portfolio.
By way of comparison, shares in other non-ETF mutual funds in the industry, including the Stone Ridge High Yield Reinsurance Risk Premium Fund Class I and Class M shares, price on a daily basis. In Europe, the most liquid funds tend to be fortnightly UCITS funds.
The cat bond ETF is being proposed at a time when liquidity in the ILS market has been under scrutiny, following a string of high cat loss years that highlighted features of the asset class that allow sponsors to lock up collateral against potential loss development.
The European Securities and Markets Authority is currently reviewing cat bonds’ eligibility for inclusion in UCITS funds, as part of a wider exploration of UCITS instruments including emission allowances and crypto assets, with an element of focus on liquidity characteristics.
In April this year, secondary market trading in cat bonds picked up markedly, with $300mn of volume traded in one week, according to a report by this publication.
Powell said: “Institutions like the trading mechanics of an ETF, with the intraday liquidity that can get that net asset value (NAV) out at the end of the day.”
He added that active managers typically do not like ETFs, because they do not want to publish a daily NAV.
The proposed offering is awaiting SEC approval by 25 September, with the firm feeling confident that this will be forthcoming.
Powell said that the liquidity profile of cat bonds had proved sufficient in Brookmont’s 2021 application to the SEC for approval for an impact investing-badged ILS ETF.
The 2021 fund did not proceed and the ESG-complimentary characteristics of cat bonds have been de-emphasized this time around.
However, Powell noted ongoing investor interest around this aspect of the ILS asset class, citing the World Bank’s $150mn Jamaica cat bond as having caught investor's attention.
Rules on ETFs allow for context around expected returns but not specific guidance.
The PM cites historical cat bond returns of around 7% and current returns of around 12%, reflecting a more constrained market, of which around 10% is risk return and 2% treasury yield.
The fund is provisionally slated for an October launch, with trading on the New York Stock Exchange under the ticker ROAR.