Catastrophe Bonds: Diversification, Risks, and Opportunities

Additional content provided by Michael McClain, CFA, Research.

With hurricane season officially coming to an end on November 30, a niche area of the investment world called Catastrophe Bonds (“cat bonds”) has time to pause from a record-breaking year of issuance. Cat bonds are insurance-linked securities designed to transfer the risk of natural disasters — such as hurricanes, earthquakes, floods, and wildfires — from large insurers to capital market participants. Investors receive a yield in return for assuming the risk that a predefined catastrophic event does not occur during the bond’s term. If the event does occur, investors may lose some or all their principal investment, which is then used to pay insurance claims.

Investor Benefits

Historically, cat bonds have provided investors with a unique risk-return profile, featuring attractive returns with event-driven downside risk. Over the past 10-years ending September 30, 2025, the Swiss Re Global Cat Bond Index has gained 6.7%, above the 6.2% gain of the Bloomberg US High Yield Index. The sole down year was a 2.2% loss in 2022. As a diversifier, correlations to traditional equity, bond, and commodity markets have been lower than 0.1 over the past 20 years.

Investor Risks

While investor benefits are attractive, the industry is not without significant risks. The most obvious being a qualifying event that results in a loss of principal. This was most recently triggered when Hurricane Melissa made landfall in Jamaica during late October. In May 2024, the Jamaican government, working with the World Bank, issued $150 million in cat bonds covering four hurricane seasons ending in 2027. Investors in the deal would receive a yield over the period unless specific storm parameters were met during a hurricane. In this case, the sustained wind speed and internal hurricane pressure were high enough to result in a 100% payout to Jamaica. These proceeds were then used to rebuild from the storm.

In addition to a triggering event, the risk of incorrect event modeling (who hasn’t complained about their local weather station’s forecasting?) and liquidity are other issues to consider. For most, understanding what drives equity and bonds markets is easier to digest than estimating sustained wind speeds over a specific country in the Caribbean. From a liquidity standpoint, as a niche market, many offerings are thinly traded and held to maturity, leading to limited secondary market activity and potentially wide bid-ask spreads.

LPL Research View

Cat bonds have historically delivered an uncorrelated return profile and acted as a source of diversification within a client’s broader credit exposure. These characteristics do come at a cost though, as investors must weigh what type of risks they want in their investment portfolios. As the performance of cat bonds is linked to independent natural disasters rather than economic cycles, investors may be substituting their knowledge of traditional market fundamentals with that of complex natural disaster simulations.

Overall, we are constructive of the industry’s growth and exposure through an experienced fund manager who maintains a small cat bond sleeve. However, given the complexity, thin liquidity, and uncertain payouts, the industry has yet to define itself as a stand-alone strategic investment.