Catastrophe bonds are yielding over 5 percent in an environment of ultra-low interest rates, but market-watchers warn investors need to take care before entering the $25 billion market.
Catastrophe bonds — or cat bonds for short — were created in the 1990s as a means of protection for insurance companies if a major natural disaster occurred and they needed to pay out large premiums. Investors typically receive a high yield on the bonds, but will have to pay out if a specific catastrophe occurs. The main risks covered are hurricanes and earthquakes, particularly in the U.S., but also Japan.
One attraction of the asset class is that it can help diversify the mix of an investment portfolio, as cat bonds typically have a low correlation with the broader financial market or economic trends. In addition, cat bonds have consistently yielded above 5 percent over the last three to four years, according to Daniel Ineichen, Schroders' head of insurance-linked securities (ILS).
"It is certainly a market that is bit different than the mainstream asset classes, but it is an interesting asset class because it still has high yields … And it is actually a market that is very uncorrelated to any developments that we have seen in the financial industry," Ineichen told CNBC on Tuesday.