Beyond the Agg: Alternative Fixed Income

Jake Coulson:

Hello everyone and welcome to the latest HANetf webinar.

My name is Jake Coulson, and today we’re going to be looking beyond the aggregate, focusing on three alternative fixed income strategies.

We’ll begin with catastrophe bonds, also known as cat bonds. For those familiar with the asset class, they are a specialist area of fixed income designed to provide exposure to insurance-linked risks, such as natural catastrophes.

For investors, they may also offer a differentiated return profile, with performance drivers that are less directly linked to traditional bond and equity markets.

Joining us to cover this theme is Rick Paani, Managing Partner and CEO at King Ridge Capital. Rick will discuss how catastrophe bonds work, why they may play a role in a diversified portfolio and where opportunities may exist in today’s market.

King Ridge Capital are partners for the actively managed KRC Cat Bond UCITS ETF, ticker CATB, which is Europe’s first cat bond ETF.

Following Rick, we’ll shift our focus to US bonds. We’re hoping to be joined by Sean Dranfield, CEO at PT Asset Management, who will discuss opportunities within the US bond market and how PT Asset Management’s approach is designed to navigate different market environments.

Finally, we’ll turn to residential mortgage-backed securities. We’ll be joined by Skyler Weinlander, CEO at Regan Capital, who will discuss the role of agency floating-rate and fixed-rate residential mortgage-backed securities and how these assets may be used within an income-focused fixed income strategy.

Regan Capital are partners for the Regan Total Return Income UCITS ETF, ticker RMBS.

Before we begin, please feel free to submit any questions using the panel at the bottom of your screen. We’ll aim to answer as many as possible throughout the session.

With that, I’ll hand over to Rick.

Rick Paani:

Thank you, Jake, and thank you everyone for participating today.

Catastrophe bonds are a truly unique asset class. We view them as largely independent from traditional credit and equity markets.

As we’re discussing bonds today, catastrophe bonds represent a high-yielding alternative to traditional fixed income. They have historically displayed low correlation with traditional markets and can act as a diversifier within portfolios.

The historical performance has been positive. One index we reference is the Swiss Re Cat Bond Index, which has experienced only one drawdown year since inception, occurring in 2022 following Hurricane Ian.

One of the key characteristics of the asset class is that it is independent of macroeconomic cycles. It is not primarily tied to credit spreads or equity markets.

When looking at correlation data, catastrophe bonds have shown very limited correlation with traditional fixed income and equity indices.

This is what makes them interesting from a portfolio construction perspective: they provide exposure to an alternative source of risk.

Rick Paani:

Looking historically, catastrophe bonds have demonstrated resilience over time.

The asset class has generally experienced relatively contained drawdowns compared with many traditional risk assets.

One reason for this is that catastrophe bonds typically reprice regularly. The maturity of these bonds is often around three to four years, but the risk exposure is reviewed annually.

The underlying risks can change over time. For example, insured exposures may increase or decrease, and spreads can adjust accordingly.

When significant events occur, the market reprices, but these movements have historically tended to be relatively shallow and can be mean reverting compared with other fixed income markets.

Rick Paani:

At a high level, catastrophe bonds allow insurance companies and reinsurers to transfer some of their exposure to natural catastrophe events into the capital markets.

The insurer or reinsurer issues a bond linked to specific risks, such as hurricanes, earthquakes or other defined events. Investors provide capital and receive a return that reflects the risk they are taking.

If a qualifying catastrophe event occurs and losses meet the predefined trigger conditions, some or all of the invested capital may be used to support insurance claims.

If the specified events do not occur, investors receive their principal back at maturity alongside the interest payments.

The important point is that the risk is not related to a company’s ability to repay debt. Instead, it is linked to the occurrence of specific insured events.

This creates a different source of return compared with traditional fixed income.

Rick Paani:

From a portfolio perspective, investors are increasingly looking for assets that can provide diversification.

Traditional fixed income portfolios are generally influenced by factors such as interest rates, inflation expectations, government policy and corporate credit conditions.

Catastrophe bonds are driven by a different set of factors, primarily the occurrence and pricing of insurance risks.

That difference can make them an interesting complement to traditional fixed income allocations.

However, investors should understand that the asset class has its own risks. The key risk is that a qualifying catastrophe event occurs, resulting in losses to investors.

Jake Coulson:

Thank you, Rick.

We’ll now move on to active fixed income.

Traditional bond investing often involves tracking broad market benchmarks. However, active managers can take a different approach by adjusting portfolio positioning based on changing market conditions.

Sean, could you explain your approach to fixed income and how it differs from traditional bond investing?

Sean Dranfield:

Thanks, Jake.

At PT Asset Management, we believe fixed income investing requires flexibility.

Traditional bond indices are often weighted based on the amount of debt issued. This means the largest issuers can represent significant parts of an index, regardless of whether those bonds offer the most attractive opportunities.

Our approach is different because we focus on security selection and actively identifying opportunities across fixed income markets.

We look at factors such as credit quality, duration, income potential and the broader market environment.

The ability to adjust positioning is particularly important because fixed income markets can change significantly as interest rates, inflation expectations and economic conditions evolve.

Sean Dranfield:

Fixed income is not a single asset class. There are many different areas, including government bonds, investment-grade credit, high yield and other forms of structured credit.

Different parts of the market can perform differently depending on the economic environment.

An active manager can seek opportunities where valuations appear attractive and adjust exposure when conditions change.

This flexibility is important because bond markets are influenced by many different factors, including central bank policy, economic growth and investor sentiment.

Sean Dranfield:

The recent market environment has highlighted the importance of flexibility.

Interest rates have moved significantly, creating both challenges and opportunities for bond investors.

After a long period where rates were very low, investors are now operating in a different environment where income generation has become a more important consideration.

Active management allows investors to access opportunities across different parts of the bond market rather than relying solely on a traditional benchmark allocation.

Jake Coulson:

Thank you, Sean.

Our final section focuses on residential mortgage-backed securities.

Skyla, could you explain what RMBS are and why investors may consider this area of the market?

Skyler Weinlander:

Thank you.

Residential mortgage-backed securities are securities backed by pools of residential mortgages.

When homeowners make mortgage payments, those cash flows flow through the structure and ultimately provide payments to investors.

The RMBS market is a significant part of the fixed income universe, particularly in the US.

Agency RMBS are securities backed or guaranteed by government-sponsored entities, which means they have different characteristics compared with many other forms of credit.

Skyler Weinlander:

One of the attractions of agency RMBS is that they can provide exposure to mortgage markets while maintaining a focus on credit quality.

The structure of these securities means investors are exposed to factors such as interest rates, mortgage prepayments and market liquidity.

A key characteristic of mortgage-backed securities is that the timing of cash flows can change depending on homeowner behaviour.

For example, when interest rates fall, homeowners may refinance their mortgages, affecting the expected duration of the security.

When rates rise, refinancing activity may slow, which can extend the duration of the investment.

Understanding these dynamics is an important part of managing RMBS portfolios.

Skyler Weinlander:

Active management is important because mortgage markets can behave differently depending on the interest rate environment.

Managers need to consider factors such as prepayment risk, duration, valuation and the structure of individual securities.

Agency RMBS offer a different risk profile compared with corporate bonds because the primary drivers are linked to mortgage behaviour and interest rate movements rather than corporate credit risk.

Jake Coulson:

Looking across all three strategies, one common theme is that investors are looking beyond traditional fixed income allocations.

Rick, Sean and Skyla, what would you say are the key reasons investors may consider these areas?

Rick Paani:

For catastrophe bonds, the key point is diversification.

The asset class provides exposure to a different type of risk compared with traditional bonds and equities.

Sean Dranfield:

For active fixed income, the opportunity comes from flexibility.

Bond markets are constantly changing, and active management allows investors to adjust positioning based on the environment.

Skyla Weinlander:

For RMBS, the opportunity comes from accessing a large and established part of the fixed income market with characteristics that differ from traditional corporate and government bonds.

Jake Coulson:

Thank you all for joining us today.

We hope this discussion has provided a useful overview of alternative fixed income strategies, including catastrophe bonds, active fixed income and residential mortgage-backed securities.

Thank you again to Rick, Sean and Skyler for sharing their insights.