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Catastrophe bond issuance spikes as sovereign yields slide

Catastrophe bond issuance is forecast to have risen almost 30 percent in 2015 to date when compared to last year, as yield-hungry investors are faced with sovereign bond yields edging towards negative territory.

Insurers are increasingly turning to catastrophe -- or "cat" bonds – to finance natural disaster risks, fund managers said. Catastrophe bond investors receive interest payments in exchange for buying bonds that are sponsored by insurers and linked to specific events, such as hurricanes or earthquakes. If one of those disasters does happen and the insurer's losses exceed a certain amount, the investors' principal can be wiped out.

This increase in demand means that some bonds are now trading at a discount to their original issue price for the first time in years.

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Damage in the Rockaway neighborhood in New York City, where the historic boardwalk was washed away during Hurricane Sandy.
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Damage in the Rockaway neighborhood in New York City, where the historic boardwalk was washed away during Hurricane Sandy.

Issuance for the year through to mid-April is predicted to be up 27 percent on 2014, at around $2.1 billion, John Seo, manager of a catastrophe bond fund at asset management group GAM, said. The full-year trend also looks positive, following on from a record cat bond issuance of $8.4 billion in 2014.

"The recently improved supply/demand balance has been beneficial for the market. We are now seeing cat bonds trading at a discount to their original issue price – something last seen back in September 2012," Seo, who also co-founded Fermat Capital Management, told CNBC.

He highlighted that on April 5, there were seven new issues released to market simultaneously.

"We believe this is a first," he said. "While cat bond spreads were higher in 2012 than they are now, lessons from the past still apply. We expect to see a similar performance pattern this year to that of 2012."

Assuming no major loss events, Seo said cat bond investors could get a return of 4–5 percent this year.

This looks especially striking when compared to yields on sovereign bonds in Europe, which continued to edge towards negative territory Thursday. Yields on German 10-year fell to a record low of around 0.09 percent, while the French 10-year slipped to a fresh low of 0.35 percent.

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The trend is so prevalent that earlier this week, U.S. investment bank Goldman Sachs said negative yields were the "new normal" in Europe.

Over 2 trillion euros ($2.1 trillion) of outstanding euro zone sovereign debt now has a negative yield, according to calculations by the bank. This move is widely thought to be exacerbated by the bond-buying program launched by the European Central Bank last month.

Partner of specialist insurance-related investor Twelve Capital, Sandro Kriesch said investment in insurance was very attractive mainly due to the lack of correlation to financial markets.

"We generated 4-8 percent for U.S. dollar investors in 2014, which we believe is very attractive," Kriesch told CNBC, highlighting that sovereign bonds in Switzerland, for example, were yielding nothing. The country became the first government in history to sell a benchmark 10-year sovereign bond at negative interest rates last week, according to reports.

"If you invest in natural disasters, you are investing in something which can be determined scientifically. The pricing of the risk is much more precise than any corporate bond or any equity investment," Kriesch added.