Why Cat Bonds Are a Powerful Fixed Income Diversifier in 2026

THE CASE FOR CAT BONDS AS A FIXED INCOME DIVERSIFIER

Cat bonds enhance fixed income returns

What are cat bonds?

Cat bonds (short for catastrophe bonds) are fixed income instruments used to transfer risks related to natural catastrophes from reinsurance companies to capital markets. As part of the broader insurance-linked securities (ILS) universe, cat bonds allow investors to access returns driven by insurance premiums rather than traditional financial market risks.

How do cat bonds work?

Instead of being used for capex like for usual corporate bonds, the proceeds are placed in a collateral to be readily available to cover insured damage resulting from events such as a hurricane in Florida or earthquake in Japan. If such an event does not occur over the life of the bond (usually 3 years), the proceeds are returned to the investor with an annual coupon made of the collateral interests plus the spread linked to the perceived risk of insurance from the related natural catastrophe (in other words, the “insurance premium”). Because returns are linked to natural events rather than economic cycles, cat bonds tend to exhibit low correlation with equities and traditional credit markets.

Performance Comparison: Cat Bonds vs Investment Grade Credit

Over the past five years, a traditional fixed income allocation (excluding Cat bonds) would have returned a cumulated performance of 13.73%, or 2.60% in compound annual growth rate. This is using the Bloomberg Global Aggregate Credit 1-5 years index hedged in USD, which already in itself would have been a wise choice as it outperformed the more traditional Global Aggregate index, thanks to its shorter duration and higher carry.

However, introducing a 12.5% allocation to Cat Bonds (equivalent tto 5% within a 40% fixed income / 60% equity portfolio), would have increased cumulative returns to 19.07%, representing an additional 5.34% of outperformance. Annualized returns would have risen to 3.55%. Importantly, this excess return was achieved with similar volatility.

Why Cat Bonds Improve Risk-Adjusted Returns?

The key driver behind this improvement is diversification.

Because cat bonds are very much decorrelated from financial markets. In fact, the weekly correlation between cat bonds and the MSCI World over the last 5 years was just 0.14 vs 0.37 for the above-mentioned credit index. Even the correlation between the cat bonds and the investment grade credit index was only 0.17 during the same period. This helps explain why, in terms of risk-adjusted return, adding some cat bonds to a fixed income allocation would have been a good decision.

They provide exposure to an uncorrelated asset class, helping smooth portfolio volatility while maintaining attractive yield levels.

Are Cat Bonds Still Attractive Today?

Today, cat bonds continue to offer compelling fundamentals. They offer a yield to maturity of 7 to 8% with no duration and no credit exposure, although with different risks uncorrelated with financial markets. By contrast, the referenced investment grade index currently offers around 4.6% yield to maturity, with 2.7 years of duration and A- average credit quality.

From a technical perspective, the outlook also supports cat bonds. Over the next couple of years, we expect massive supply of debt in the investment grade universe as issuers like Oracle need to finance their enormous AI capex. With developed market governments also having to refinance ever growing fiscal deficits, it is unclear how much demand will be left to meet the new supply of investment grade debt corporate bonds. This expanding debt supply may pressure traditional credit markets, reinforcing the case for diversifying fixed income exposure with alternative sources of return such as catastrophe bonds.

Manager Selection matters

One word of caution: Cat bonds are a specialized and complex asset class. Manager selection is therefore critical. Investors should prioritize experienced managers with strong underwriting capabilities, proven track records, and sufficient agility to exploit opportunities in the developing secondary market of this approximately $65bn sector.

Written by Julien Baltzinger

 

 

 

 

 

Past performance is not indicative of future results. The views, strategies and financial instruments described in this document may not be suitable for all investors. Opinions expressed are current opinions as of date(s) appearing in this material only. References to market or composite indices, benchmarks or other measures of relative market performance over a specified period of time are provided for your information only.

NS Partners provides no warranty and makes no representation of any kind whatsoever regarding the accuracy and completeness of any data, including financial market data, quotes, research notes or other financial instrument referred to in this document. This document does not constitute an offer or solicitation to any person in any jurisdiction in which such offer or solicitation is not authorized or to any person to whom it would be unlawful to make such offer or solicitation.

Any reference in this document to specific securities and issuers are for illustrative purposes only, and should not be interpreted as recommendations to purchase or sell those securities. References in this document to investment funds that have not been registered with the FINMA cannot be distributed in or from Switzerland except to certain categories of eligible investors.

Some of the entities of the NS Partners Group or its clients may hold a position in the financial instruments of any issuer discussed herein, or act as advisor to any such issuer.  Additional information is available on request.


© NS Partners Group

How to navigate the credit crisis?

Credit crisis?

Three years after interest rates started rising, credit accidents are multiplying. How should one position themselves in this context?

The First Cracks in the U.S. Economy

Last September, three years after the FED began its remarkable rate-hiking cycle, the first cracks began to appear in the wall of the American economy. Tricolore and First Brands suddenly filed for bankruptcy, resulting in hundreds of millions, if not billions, of dollars in losses for their creditors. Among them were major investors, including JP Morgan, whose CEO Jamie Dimon made headlines with a viral metaphor: “When you see one cockroach, there are probably more,” referring to the recent developments in the credit space.

In October, it was the turn of two regional banks (Zions Bancorp and Western Alliance Bancorp) to fall victim to potential fraud in the commercial mortgage market. While losses for these two institutions amount to “only” tens of millions of dollars, the impact is more significant given the small size of their balance sheets.
Following these seemingly isolated cases, confidence in the financial system was severely tested, with a combined USD100 billion drop in market capitalization among the country’s 74 largest banks, signaling a potential upcoming economic slowdown.

Risks to Avoid Amid Economic Slowdown

The private credit market, which has seen phenomenal enthusiasm in recent years, was quickly blamed. It is true that its recent success stirs up envy and some indulge in a bit of “Schadenfreude,” prematurely celebrating its setbacks. But in this space, not all managers are created equal. While some big names in the sector are facing significant losses, other players have so far remained unscathed.

In such a context, extreme diligence in selecting a private credit manager is crucial, as performance differences between the top and bottom quartiles can be significant. It is particularly important to favor the most experienced managers, those who have been through several credit cycles, over those who have merely ridden the wave of this asset class in recent years. And when one is not able to do this themselves, it’s essential to rely on a firm that knows how to identify the best talent in the field.

For example, the best managers are better able to distinguish between resilient issuers and those with a weaker credit profile due to over-indebtedness, business models at risk of disruption by artificial intelligence or other characteristics that may escape the less trained eye.

Opportunities and Alternatives to Conventional Credit

Though worrisome at first glance, these recent events may present tremendous opportunities. Long-short credit managers, for example, may be able to stand out. Again, rigorous manager selection is essential, especially given the high leverage levels inherent to this type of strategy.

For those wishing to avoid exposure to corporate and private credit altogether, there are still a few interesting alternatives offering similar returns with different types of risk. “Cat bonds” (catastrophe bonds), for example, provide total decorrelation from the credit market by being exposed instead to natural disasters such as hurricanes or earthquakes. Finally, local currency emerging market debt, after a stellar start to the year, continues to offer fabulous returns, thanks to high real interest rates and attractive fundamental valuations of local currencies against the dollar.

Thus, in today’s environment, manager selection remains a key factor but not the only one. The ability to identify alternatives to conventional credit and build diversified portfolios across different risk sources also plays a vital role.

 

 

 

Past performance is not indicative of future results. The views, strategies and financial instruments described in this document may not be suitable for all investors. Opinions expressed are current opinions as of the date(s) appearing in this material only. References to market or composite indices, benchmarks or other measures of relative market performance over a specified period of time are provided for your information only. NS Partners provides no warranty and makes no representation of any kind whatsoever regarding the accuracy and completeness of any data, including financial market data, quotes, research notes or other financial instruments referred to in this document. This document does not constitute an offer or solicitation to any person in any jurisdiction in which such offer or solicitation is not authorized or to any person to whom it would be unlawful to make such offer or solicitation. Any reference in this document to specific securities and issuers are for illustrative purposes only, and should not be interpreted as recommendations to purchase or sell those securities. References in this document to investment funds that have not been registered with the Finma cannot be distributed in or from Switzerland except to certain categories of eligible investors. Some of the entities of the NS Partners group or its clients may hold a position in the financial instruments of any issuer discussed herein, or act as advisor to any such issuer. Additional information is available on request.  © NS Partners Group

Chart of the Month: April 2025 Inflation & Yield Curve Risks

Chart of the Month:
Inflation and the Yield Curve This Chart of the Month examines whether inflation is truly transitory and what the recent steepening of the US yield curve signals for markets.

April 2025 Inflation & Yield Curve – Chart of the Month

 

Is the inflation transitory this time?

At the press conference after the last FED meeting on Wednesday 19th of March, FED chairman Jerome Powell, used the infamous T word to describe the impact that tariff would have on inflation in the short term. While he could well be right, the use of the term “transitory” for describing inflation was very bold as it revives fresh memories of what is probably the worst monetary policy mistake of this decade.

The FED preferred measure for inflation, the core PCE price index (the dark blue line in the chart) was at 2.8% in February on a year over year basis. This level is not alarming in itself. What is more concerning however is that the inflation has not made further progress since May last year (as reflected by the dark blue arrow on the chart) while still being above the 2% FED target.

As the US growth is showing some signs of weakness and the FED made it clear that they view the recent elevated inflation numbers as only a short-term impact from tariffs, the bond market is pricing 3 FED cuts for the year, which would take the FED fund rate at 3.75% in December.

What does it mean for future inflation and the yield curve? Since the start of the year, the inflation expectations one year from now (the light blue line in the chart) has rebounded from 5% to 6.2% as consumers are getting worried of price hikes. Since inflations expectations tend to be self-fulfilling prophecies, this could trigger an upshot in the core PCE price index.

The yield curve can be approximated by the difference between the 10-year nominal yield and the 2-year nominal yield (the dark grey line in the chart). This measure has gone from -36 bps to +32 bps since last May when disinflation progresses stalled (as shown by the dark grey arrow). And as one of the major drivers for its slope is the inflation uncertainty, we could be witnessing the start of a bear steepening, where the 10-year nominal yield rises faster than the 2-year yield.

This is very important because we have seen previously that a steepening yield curve tend to lead to credit spreads widening (which started this year) and ultimately recessions. While we are not calling for a recession in the US just yet, it is becoming a greater risk amid political uncertainty.

Therefore, stay careful with your credit exposure and watch out for the curve steepening!

 

 

 

 

Past performance is not indicative of future results. The views, strategies and financial instruments described in this document may not be suitable for all investors. Opinions expressed are current opinions as of date(s) appearing in this material only. References to market or composite indices, benchmarks or other measures of relative market performance over a specified period of time are provided for your information only. NS Partners provides no warranty and makes no representation of any kind whatsoever regarding the accuracy and completeness of any data, including financial market data, quotes, research notes or other financial instrument referred to in this document. This document does not constitute an offer or solicitation to any person in any jurisdiction in which such offer or solicitation is not authorized or to any person to whom it would be unlawful to make such offer or solicitation. Any reference in this document to specific securities and issuers are for illustrative purposes only, and should not be interpreted as recommendations to purchase or sell those securities. References in this document to investment funds that have not been registered with the FINMA cannot be distributed in or from Switzerland except to certain categories of eligible investors. Some of the entities of the NS Partners Group or its clients may hold a position in the financial instruments of any issuer discussed herein, or act as advisor to any such issuer.  Additional information is available on request.
© NS Partners Group

Yield curves: Bund or Treasuries?

Yield curves: Bund or Treasuries?

The gap between the main yield curves on either side of the Atlantic has narrowed sharply this year.

Fiscal policies have run ahead of monetary policies

Over the past five years, ten-year rates in the United States and Germany have stood at 2.80% and 1.15% respectively on average, with an average gap of 1.65% between the two yield curves. However, this gap narrowed from 2.21% to 1.47% between the beginning of the year and 7 March. This relatively impressive movement is not due, as one might usually think, to a divergence in the monetary policies of the FED and the ECB, but rather to the gap between the recent fiscal policies of these two countries. Although Donald Trump’s approach to US corporate taxation is expansionist, his policy on customs tariffs and the economic uncertainty it generates are having a detrimental effect on the country’s economy. Indeed, on 7 March, the Atlanta Fed model – which aims to estimate current US GDP growth – projected a fall of 2.4% in the first quarter of 2024. In fact, the situation has changed drastically on the other side of the Atlantic, paradoxically because of Mr Trump’s policies. While Mr Trump is sending out more and more negative signals about US involvement in the defence of Ukraine and more generally about its military support for Europe, the leaders of the new German coalition government, made up of centre-right and centre-left parties and led by the future chancellor Friedrich Merz, have announced an unprecedented set of measures that could add around 2. 5% of GDP to annual expenses. In view of these recent events, the relative movements observed on the two yield curves therefore seem entirely justified and the volatility that has set in on the market could well continue for some time yet.

The growing role of rates in the performance of a bond portfolio

Meanwhile, credit spreads continue to move at extremely tight levels. To be sure, the fundamentals largely justify this, as the balance sheets of companies and banks have been greatly cleaned up in recent years. It is also true that there remains a disparity in some credit universes that can benefit long/short credit managers who are able to bet both on the upside and the downside of the credit quality of different issuers. Nevertheless, for a more conventional bond allocation, combining sovereign bonds from developed markets and bonds from good quality companies and financial institutions, the current spread levels represent 37 basis points on an overall yield of 3.98% (all currencies combined), i.e. less than 10% of the total yield. By way of comparison, the average for the last five years was almost double that, or 19% of the total return. In view of the volatility on the various yield curves mentioned above, it is therefore essential to be cautious about exposure to them.

The importance of actively managing exposure to the various yield curves

There are many ways to build a diversified bond portfolio, whether in terms of credit risk, duration in general or exposure to different yield curves. On this last point, it may be worthwhile to focus on a flexible strategy that can adapt to changes in structural trends, as these will certainly have a historically significant impact on the performance of an overall bond portfolio exposed to US and German rates in particular.

 

 

 

Past performance is not indicative of future results. The views, strategies and financial instruments described in this document may not be suitable for all investors. Opinions expressed are current opinions as of the date(s) appearing in this material only. References to market or composite indices, benchmarks or other measures of relative market performance over a specified period of time are provided for your information only. NS Partners provides no warranty and makes no representation of any kind whatsoever regarding the accuracy and completeness of any data, including financial market data, quotes, research notes or other financial instruments referred to in this document. This document does not constitute an offer or solicitation to any person in any jurisdiction in which such offer or solicitation is not authorized or to any person to whom it would be unlawful to make such offer or solicitation. Any reference in this document to specific securities and issuers are for illustrative purposes only, and should not be interpreted as recommendations to purchase or sell those securities. References in this document to investment funds that have not been registered with the Finma cannot be distributed in or from Switzerland except to certain categories of eligible investors. Some of the entities of the NS Partners group or its clients may hold a position in the financial instruments of any issuer discussed herein, or act as advisor to any such issuer. Additional information is available on request.  © NS Partners Group

Chart of the Month – Credit investors: beware of the re-steepening

Credit investors: beware of the re-steepening

 

 

The slope of the US yield curve, which can be illustrated among other examples, by the difference between the US 10-year yield and the US 2-year yield has been widely used as an early indicator of recessions. Its normal slope should be positive, which means fixed income investors should be rewarded with a higher yield for buying bonds with longer maturities because, among other things, they sacrifice visibility on future inflation path and economic activity.

In the past, however, the yield curve has inverted various times between the 10-year and 2-year maturities. Some of those times include 1929, 1974 and 2008, where the inversion lasted particularly long and was followed by some well-known turbulences in the market.

The reason for these turbulences can be explained as follow: as the economy is slowing down, inflation is falling and unemployment starts rising, the market anticipates that the FED will have to cut rates to avoid a recession and to protect the labor market. Although the long-term part of the curve tends to move lower on the prospect of slower economic growth, the front end is much more reactive in reflecting the expected rate cuts from the FED. This mechanism creates what we call a bull steepening of the yield curve, where the 2-year yield drops faster than the 10-year yield.

The impact on credit spreads (a gauge of credit risk) is usually negative as we normally see a flight to safety during these periods of stress, where investors will favor quality over speculative assets, in other words, investment grade over high yield.

Over the last 30 years, as seen on the chart of this month, such occurrences also included the dot com bubble and the Covid pandemic. The shaded rectangles represent the period from the lowest point in the yield curve slope (in blue) and its highest point in the cycle. The dotted blue line is the frontier where the curve becomes inverted or positive again. We can see that credit spreads (in orange) have spiked in each of these periods to a cycle high.

Contrarily to a common misconception, it is not so much the yield curve inversion that coincides with spikes in credit spreads, but rather the re-steepening following these inversions. If we take the global financial crisis, for example, we can see that the yield curve started to invert in late 2005 already, without triggering any widening in credit spreads. It is only in the summer of 2007 (a few months after the curve hit the bottom and started rebounding) that the spreads spiked from a low of 240bps to a frightening high of 1’830bps.

As we can see in the chart, the yield curve has been inverted for more than 2 years in this cycle and has now re-steepened an impressive 124bps.

Today, credit spreads have remained muted and are below their historical average (the dotted orange line). It is of course not certain that history will repeat itself and that they will spike to new highs, but it is very unlikely that they will remain at such tight levels, especially given the uncertainty stemming from the approaching US elections and the two ongoing conflicts in Ukraine and in the Middle East.

Therefore, in such an environment, one should beware of the re-steepening of the yield curve and favor a higher quality in his or her credit portfolio.

 

 

 

 

 

Past performance is not indicative of future results. The views, strategies and financial instruments described in this document may not be suitable for all investors. Opinions expressed are current opinions as of date(s) appearing in this material only. References to market or composite indices, benchmarks or other measures of relative market performance over a specified period of time are provided for your information only. NS Partners provides no warranty and makes no representation of any kind whatsoever regarding the accuracy and completeness of any data, including financial market data, quotes, research notes or other financial instrument referred to in this document. This document does not constitute an offer or solicitation to any person in any jurisdiction in which such offer or solicitation is not authorized or to any person to whom it would be unlawful to make such offer or solicitation. Any reference in this document to specific securities and issuers are for illustrative purposes only, and should not be interpreted as recommendations to purchase or sell those securities. References in this document to investment funds that have not been registered with the FINMA cannot be distributed in or from Switzerland except to certain categories of eligible investors. Some of the entities of the NS Partners Group or its clients may hold a position in the financial instruments of any issuer discussed herein, or act as advisor to any such issuer.  Additional information is available on request.
© NS Partners Group

What duration for a bond portfolio?

What duration for a bond portfolio?

A few thoughts as the FED prepares to launch its rate-cutting cycle.

Duration back in the spotlight

Since the financial crisis of 2008 and the economic repression introduced by central banks through their quantitative easing programmes, long-dated bonds had lost some of their appeal. The last remaining attraction disappeared in the aftermath of the Covid crisis, when the same central banks injected massive amounts of liquidity into the market, sending bond yields falling. In fact, it hardly seemed relevant to invest in long-term bonds with yields close to zero. Since 2021, however, we have seen a paradigm shift, with the return of inflation forcing the Fed, in particular, to raise its key rates to an extent never seen before. Today, the US central bank is about to embark on a cycle of rate cuts (which have remained unchanged at around 5.25% since July 2023), against the backdrop of an economic slowdown marked by a weaker job market. These fears about growth are finally driving down the correlation between equities and bonds and, in this context, duration is once again becoming an attractive option for building an investment portfolio.

Favour short to intermediate durations

For the sake of simplicity, let’s focus on developed markets and run the US 10-year yield as a proxy for longer-dated bonds. To mechanically determine a theoretical target value for this yield, we can start from the FED’s neutral key rate, given by its last dot plot in June (2.8%) and add a time premium to it, which will vary according to the reference period and which is justified in particular by the uncertainties linked to future inflation. Historically, this premium between the Fed’s key rate and US 10-year yields has been between 1% and 2% or between 0.5% and 1.5% since the 2008 financial crisis. Taking averages, we can therefore conclude that the US 10-year yield should be 4.3%, if we assume that we are moving away from the paradigm that has prevailed since the financial crisis, or 3.8%, if we assume that we are still in a similar context. At the time of writing, the US 10-year yield is 3.66%. We can therefore conclude that, in theory and in the absence of a hard landing marked by a recession in the United States, long-term bond prices (which move inversely to yields) are slightly overvalued by the market. On top of this, the fundamentals are not very reassuring about the sustainability of the US budget, with deficits comparable to those in the days following the Second World War. Investing in this type of investment therefore does not seem appropriate.

A more reasonable option, and one that nevertheless adds a little duration to a portfolio, would be to opt for a short to intermediate duration. Here, we can run the 2-year rate, for example. Replicating the same analysis as for long rates, we obtain a historical time premium of 0.5% to 1% and almost zero for the period following the financial crisis, which gives us theoretical target values of between 2.8% and 3.55% depending on the macroeconomic context, whereas the current yield is 3.56%. We can see here that the market value and the theoretical price are more in line and that there is even an opportunity if we stay in a market similar to the post-financial crisis period.

The investor’s context

In reality, there is no exact universal solution when it comes to choosing duration within a portfolio, as each portfolio has its own characteristics to meet the needs of the client. An approach that favours the long end of the curve may still be justified, for example to hedge the risk associated with a portfolio that has a high exposure to cyclical equities. First and foremost, you need to identify the risk and return constraints specific to each portfolio before making your choice. It is also important to take a macroeconomic view when deciding on the time premium to be added to the target return for each maturity. These points are not intended to be exhaustive, but they should help bond investors in their allocation decisions at a time when duration is finally regaining popularity.

 

 

 

Past performance is not indicative of future results. The views, strategies and financial instruments described in this document may not be suitable for all investors. Opinions expressed are current opinions as of date(s) appearing in this material only. References to market or composite indices, benchmarks or other measures of relative market performance over a specified period of time are provided for your information only. NS Partners provides no warranty and makes no representation of any kind whatsoever regarding the accuracy and completeness of any data, including financial market data, quotes, research notes or other financial instrument referred to in this document.

This document does not constitute an offer or solicitation to any person in any jurisdiction in which such offer or solicitation is not authorized or to any person to whom it would be unlawful to make such offer or solicitation. Any reference in this document to specific securities and issuers are for illustrative purposes only, and should not be interpreted as recommendations to purchase or sell those securities. References in this document to investment funds that have not been registered with the FINMA cannot be distributed in or from Switzerland except to certain categories of eligible investors. Some of the entities of the NS Partners Group or its clients may hold a position in the financial instruments of any issuer discussed herein, or act as advisor to any such issuer. Additional information is available on request.

© NS Partners Group