Beta-seeking fixed income managers and mutual funds are driving pricing dynamics at the margins within the cat bond market, despite the deepening role of pension funds within the ILS space.
There are suggestions in some quarters that over the past year fixed income managers and mutual funds have displaced pension funds as the leading driver of cat bond pricing. The result has been declining spreads, as the new entrants have been able to benefit from lower cost of capital than their pension fund peers.
They are also entering the space for different reasons. Rather than making a long-term allocation of capital, they have tended to be more opportunistic. Nevertheless, their marginal role is having a telling impact on the space.
One of the issues associated with the new dynamic is that the beta group is not interested in unlocking risk in the same way that pension funds are. For them, they are encouraging cedants into the space by pricing cat bonds relatively tight to reinsurance programmes, but by doing so they are introducing competing, not complementary, capital.
This has led to a situation where there is too much beta capital, chasing too little risk. Cat bond spreads have come down steadily as a result.
Pension funds can do little in response, but are becoming increasingly entrenched within the cat bond market, and despite the headwinds associated with the influx of recent beta chasers, will likely enjoy strong input concerning the long-term pricing of cat risk.
Cat bonds, ILS, pricing, convergence, alternative capital