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Catastrophic Bonds and Their Role in Modern Investment Strategies · Views from 6,230

• 0:10
  Ryan Nauman Host Views from 6,230: Welcome everyone when hurricanes, wildfires, earthquakes, and natural disasters strike, the financial impact can be staggering, particularly for insurers.
• 0:21
  Ryan Nauman Host Views from 6,230: But what if investors could help shoulder that risk while potentially earning income and diversifying their portfolios?
• 0:30
  Ryan Nauman Host Views from 6,230: I have on the perfect guest to shed some light on the topic and what it all means for financial advisors as they build investment portfolios.
• 0:40
  Ryan Nauman Host Views from 6,230: But first, this episode is sponsored by the award-winning Zephyr, which helps investment professionals make more informed investment decisions on behalf of their clients.
• 0:50
  Ryan Nauman Host Views from 6,230: All right, enough from me.
• 0:51
  Ryan Nauman Host Views from 6,230: I have already talked enough.
• 0:53
  Ryan Nauman Host Views from 6,230: Let's go ahead and bring on the star of the show.
• 0:56
  Ryan Nauman Host Views from 6,230: I am honored and very excited to welcome Ethan Powell.
• 1:00
  Ryan Nauman Host Views from 6,230: Ethan is a principal and chief investment officer at Brookmont Management.
• 1:08
  Ryan Nauman Host Views from 6,230: thank you so much for coming on the show.
• 1:10
  Ryan Nauman Host Views from 6,230: It's an honor to have you on.
• 1:12
  Ryan Nauman Host Views from 6,230: Really excited about this conversation.
• 1:14
  Ryan Nauman Host Views from 6,230: Living up in Lake Tahoe, we know all about, unfortunately, about wildfire season.
• 1:19
  Ryan Nauman Host Views from 6,230: It's almost like now there isn't a wild season.
• 1:21
  Ryan Nauman Host Views from 6,230: It's So really interested about this.
• 1:24
  Ryan Nauman Host Views from 6,230: Can you please tell us a little bit more about yourself and Brookmont Capital Management?
• 1:29
  Ethan Powell Principal & CIO Brookmont Capital Management: Sure.
• 1:30
  Ethan Powell Principal & CIO Brookmont Capital Management: I've got a 20-plus year investment experience primarily in alternatives, distressed debt alternative income strategies, which is why I love catastrophic bonds.
• 1:41
  Ethan Powell Principal & CIO Brookmont Capital Management: Started investing in them pre-'08.
• 1:43
  Ethan Powell Principal & CIO Brookmont Capital Management: And they've changed a lot over the years, which I think hopefully we'll dig into.
• 1:48
  Ethan Powell Principal & CIO Brookmont Capital Management: But Brickmark Capital, we're a $1.2 billion asset manager based in the very hot Dallas, Texas right now.
• 1:54
  Ethan Powell Principal & CIO Brookmont Capital Management: We specialize in alternative income-oriented strategies both in equity and fixed income markets.
• 2:00
  Ethan Powell Principal & CIO Brookmont Capital Management: We launched, as you mentioned, the first catastrophic bond ETF last year.
• 2:06
  Ethan Powell Principal & CIO Brookmont Capital Management: It's ticker ILS.
• 2:07
  Ethan Powell Principal & CIO Brookmont Capital Management: And our goal is, not only to provide access to this fantastic asset class, but really educate the investing public on the opportunities it provides, and maybe more importantly, the function it serves in our society in, in helping people
• 2:23
  Ethan Powell Principal & CIO Brookmont Capital Management: stay insured in high peril areas in making housing affordability more attainable and through increasing price transparency and scale in the asset class
• 2:34
  Ryan: Ethan, that's fantastic, and it's interesting.
• 2:36
  Ryan: I have had some conversations about, natural disasters, and especially here, like for example, Lake Tahoe, a lot of places in California, Florida, it is really hard to get insurance now.
• 2:47
  Ryan: Homeowners insurance, very difficult.
• 2:50
  Ryan: In fact, there's a lot of places in Lake Tahoe we can't get insurance.
• 2:54
  Ryan: We've gotta go through the Cal FAIR Act to Which is very expensive.
• 2:59
  Ryan: So how
• 2:59
  Ethan Powell: Yep
• 3:00
  Ryan: Katterfaugh bonds that?
• 3:02
  Ryan: You kinda mentioned it in your intro.
• 3:04
  Ryan: Can you go maybe more into a little bit more detail there?
• 3:08
  Ethan Powell: Yeah.
• 3:08
  Ethan Powell: Insurance by its nature is a relatively opaque marketplace, right?
• 3:12
  Ethan Powell: You have all these actuaries on the insurer side crunching numbers.
• 3:16
  Ethan Powell: They've got certain break even and profitability goals that they're looking at.
• 3:21
  Ethan Powell: And, if a particular peril or geography doesn't meet that, then they might exit or start writing out specific perils or exiting geographies altogether, right?
• 3:32
  Ethan Powell: And what the catastrophic bond market does is, in addition to reinsurance, which is really the primary way they offset some of the risk, it provides access to alternative pools of capital.
• 3:44
  Ethan Powell: And one of the reasons we like cat bonds generally, but then the ETF more specifically, is the pricing transparency that it brings to market, right?
• 3:54
  Ethan Powell: So if I'm an insurer and reinsurer and I'm packaging up a peril in a geography there's something called a trigger, right?
• 4:02
  Ethan Powell: Which is, hey, it...
• 4:04
  Ethan Powell: will this get impaired if certain wind speeds are met or seismic activity is detected?
• 4:10
  Ethan Powell: Or there's another per- or another trigger type called indemnity, which is more common, which is I'm an insurer, if my losses exceed a certain amount over a given time period within a specific geography and a specific peril type,
• 4:24
  Ethan Powell: then this bond helps to offset some of those risks.
• 4:28
  Ethan Powell: But keep in mind, they're very much tail risks, right?
• 4:31
  Ethan Powell: We're talking one in a hundred year type storms, one in five hundred year type storms.
• 4:36
  Ethan Powell: But what cat bonds does is it kind of packages this entire ecosystem that I think is very foreign to traditional investors and creates an opportunity for them to participate.
• 4:48
  Ethan Powell: And what that does is it forces the insurers and reinsurers to create market terms, right?
• 4:55
  Ethan Powell: So risk spread, some of those trigger types, what's called attachment point, which is the, insured damage.
• 5:01
  Ethan Powell: And so it brings greater transparency and a little more price discovery and and then ultimately scalability which hopefully will allow some of those insurers to stay in markets and not have, as you mentioned, the California fire bonds have
• 5:19
  Ethan Powell: to kick in, which are very expensive, right?
• 5:21
  Ethan Powell: So it's just another alt- alternative form of capital bringing scale and transparency to an oth- otherwise opaque market.
• 5:28
  Ryan: Yeah, that's fantastic, Ethan.
• 5:29
  Ryan: We're gonna talk more about just the bonds in general and how they can impact investment portfolios and the risk reward there.
• 5:38
  Ryan: But how does, we talk about the natural disaster.
• 5:41
  Ryan: It seems like every year there, there's more natural disasters, whether it's a hurricane, fires, earth- you name it for whatever reason.
• 5:49
  Ryan: We won't go there, Ethan, but how has this impact how insurers assess and transfer risk?
• 5:57
  Ethan Powell: It's interesting that you say that.
• 5:58
  Ethan Powell: So last year was a great example.
• 6:00
  Ethan Powell: There was about $108 billion of insured losses.
• 6:05
  Ethan Powell: Of that, 45 billion or so were the LA wildfires.
• 6:09
  Ethan Powell: The balance though was really what's called severe convective storms, and also primarily in the Midwest, right?
• 6:16
  Ethan Powell: So not a lot of cat bonds dealing with wind damage or h- or tornadoes in Michigan, for example, right?
• 6:25
  Ethan Powell: But increasingly some of these other non-traditional geographies are starting to incorporate cat bonds for the reasons you pointed out, just increased climate volatility and uncertainty in general.
• 6:37
  Ethan Powell: But anyway, so you juxtapose the 108 a- and the severe convective storms with a hurricane season that saw three Cat 5 hurricanes, which the most on record is four Cat 5 hurricanes in 2005.
• 6:50
  Ethan Powell: So it was very much anomalous from the standpoint of several large storms.
• 6:56
  Ethan Powell: However, not a single named hurricane hit the contiguous United States, right?
• 7:02
  Ethan Powell: You're All of these different factors.
• 7:04
  Ethan Powell: So you may have some vol- extreme volatility, but it matters when and where it hits.
• 7:09
  Ethan Powell: And that really ultimately impacts the cat bond market as much as just total volume of insured losses.
• 7:15
  Ethan Powell: A- as far as insurers are concerned it's a difficult game as volatility increases.
• 7:20
  Ethan Powell: Maybe we'll touch on AI.
• 7:21
  Ethan Powell: I think AI is definitely helping them catch up to that volatility and helping to price that risk more accurately and fairly
• 7:30
  Ryan: Ethan, that's a perfect segue.
• 7:32
  Ryan: Let's talk about AI.
• 7:33
  Ryan: It's like we- every conversation has some type of connection to AI, so let's go there.
• 7:39
  Ryan: How has AI impacted insurers and how they plan and predict natural disaster?
• 7:44
  Ryan: Has it become more accurate, in their prediction models?
• 7:48
  Ryan: Or like, how has
• 7:49
  Ethan Powell: What's interesting is, and, we're still, I think, early stages as it relates to AI adoption in this space.
• 7:55
  Ethan Powell: But, you have Verisk and some of these other services that have been using natural language processing for years.
• 8:00
  Ethan Powell: It just wasn't called AI.
• 8:01
  Ethan Powell: What's interesting to your point, Ryan, on, on the predicting aspect is there hasn't been a great uptick in accuracy of longer term forecasting necessarily.
• 8:12
  Ethan Powell: But what it has allowed issuers to do is much more quickly assess potential damage and risk of a pending storm and more quickly respond to estimated insured losses post-storm as well.
• 8:27
  Ethan Powell: And then, another thing that it's really helped to do is helped the primary issuance market right?
• 8:33
  Ethan Powell: When you're setting out the terms of specific issues, you have much more data and accurate data to bring to market, and I think the market as a whole feels more conf comf- comfortable and confident in some of the
• 8:46
  Ethan Powell: assumptions being used in reconciling that to the terms of the actual cat bond itself.
• 8:52
  Ethan Powell: So speed to market speed in processing the implications of specific natural disasters.
• 8:59
  Ethan Powell: But as of yet, longer term forecasting, there hasn't been a noticeable uptake, but I think it'll come
• 9:05
  Ryan: Yeah.
• 9:06
  Ryan: And like you said we're early in the game.
• 9:09
  Ryan: It's still early.
• 9:10
  Ethan Powell: Oh, one thing that you'll find interesting, Ryan, actually with your wildfire exposure is it's, it- AI is also allowing issuers to model harder to model tr- perils like wildfires.
• 9:23
  Ethan Powell: Historically, it's been a very difficult 'Cause there's man-made influences, there's lightning strikes, there's undergrowth, et cetera.
• 9:32
  Ethan Powell: But AI has definitely helped for, for these non-traditional perils take in unstructured data and create a, a far more accurate picture of what the risks are.
• 9:43
  Ethan Powell: And that resulted last year in the largest wildfire cat bond issuance.
• 9:49
  Ethan Powell: It's only four billion, but but still it was significantly higher than the previous record
• 9:55
  Ryan: Just in.
• 9:56
  Ryan: Yeah, the lightning risk, hey, you don't think about, but it started a lot of fire.
• 10:00
  Ryan: It just started a fire a few weeks ago.
• 10:02
  Ryan: It was put out quickly, but,
• 10:05
  Ethan Powell: there's, I think it was 3.5 million acres this year have been impacted by wildfires with 38,000 different wildfires reported.
• 10:15
  Ethan Powell: So it's just, that's a tough, that's a tough peril to model as you can imagine, right?
• 10:21
  Ryan: Exactly.
• 10:22
  Ryan: And it happens too in places that don't neces- it's not like there needs to be huge forest for a fire to happen
• 10:29
  Ethan Powell: To your point, Utah year to date has had more wildfire damage than they have in the last four years combined.
• 10:35
  Ethan Powell: And obviously you've got some very ve- highly vegetated areas of Utah, but it's a lot of desert in Utah also, so
• 10:44
  Ryan: Yeah, you're exactly correct.
• 10:46
  Ryan: Exactly correct.
• 10:47
  Ryan: So are insurers doing?
• 10:49
  Ryan: You- I think I know the answer here, you've covered it.
• 10:52
  Ryan: What are insurers doing to transfer the risk of natural disasters so they don't bear 100% of the risks?
• 11:01
  Ethan Powell: You, I like to start at what is the motivation, right?
• 11:04
  Ethan Powell: The motivation isn't necessarily to screw over the investing public, right?
• 11:09
  Ethan Powell: The motiv- insurers and reinsurers are in the business of underwriting risk, right?
• 11:14
  Ethan Powell: And the more risk they can underwrite, the more money they make.
• 11:17
  Ethan Powell: And the more...
• 11:18
  Ethan Powell: That means the more risk that they can offload, it creates capacity for them to underwrite more.
• 11:24
  Ethan Powell: So I like to talk about, like a hypothetical example.
• 11:27
  Ethan Powell: If Allstate has the goal of owning the Houston property and casualty market, and they do that, and they have m- massive market share they wake up one day and they realize we're way overexposed to hurricanes.
• 11:39
  Ethan Powell: We'd love to underwrite more risk, but what are we gonna do in the event that this hurricane happens?"
• 11:45
  Ethan Powell: It could, take the firm under, right?
• 11:48
  Ethan Powell: So what they'll do is they'll issue a catastrophic bond for Houston specifically, and it may be something like in the next three years if insured damages from named hurricanes in Houston exceed $5 billion, this $500 million bond will
• 12:04
  Ethan Powell: start to pay 20% of every claim over 5 billion, for example, right?
• 12:09
  Ethan Powell: But what that allows them to do is to free up some of that risk capacity to continue to underwrite property and casualty in the Houston area while offloading some of that tail risk, right?
• 12:21
  Ethan Powell: And another important point is that, you may say then I'm exposed to Allstate going out of business if something happens."
• 12:29
  Ethan Powell: But these cat bonds that we invest in are called 144A fully cash collateralized cat bonds.
• 12:35
  Ethan Powell: So when you put your money in the primary market, the money just sits there in basically an SPV collateral account earnings SOFR, right?
• 12:44
  Ethan Powell: So 4%.
• 12:46
  Ethan Powell: And that's your base rate.
• 12:47
  Ethan Powell: And then the, the insurer is contractually obligated to divert premiums to help pay that risk premium, which, right now is, call it like 7% depending on where you are as far as risk profile.
• 13:00
  Ethan Powell: But that's So the intent of the insurer is to defray some of that tail risk and the ultimate outcome is the insurers and reinsurers have greater capacity to make insurance product more available to people living in high peril
• 13:15
  Ethan Powell: areas
• 13:17
  Ryan: Perfect example.
• 13:18
  Ryan: That was really gonna be my next question is how do they work and what they are, but your example using Houston was spot on.
• 13:26
  Ryan: the interest that i- that roughly base 4% that's coming from insured part of their premiums
• 13:36
  Ethan Powell: So the base is coming from just the collateral sitting, earning SOFR, and then that risk premium is diverted premiums effectively from Houston in that example
• 13:47
  Ryan: Fantastic.
• 13:48
  Ryan: So what are the benefits of cat bonds?
• 13:51
  Ryan: What, what benefit do they bring investors?
• 13:54
  Ryan: Correlation reduced correlation, or is it just higher yields?
• 13:59
  Ryan: What are some of the benefits?
• 14:01
  Ethan Powell: Both of those.
• 14:02
  Ethan Powell: I would-- I think the lead benefit is diversification, right?
• 14:06
  Ethan Powell: And I think you see a lot of alternative income asset classes claim that, but what in the numbers is those asset classes tend to become highly correlated during periods of market drawdown.
• 14:19
  Ethan Powell: And that's ultimately because in some form or fashion, they are, you're assuming risk of credit risk, either corporate or sovereign, right?
• 14:28
  Ethan Powell: Equity market risk, rate risk, all of these different risks that tend to become highly correlated in periods where you need that diversification the most.
• 14:37
  Ethan Powell: And what's beautiful about this asset class is you're assuming none of that, right?
• 14:44
  Ethan Powell: You're assuming catastrophic natural disaster risk, which has nothing to do with what's going on in Iran, what Warsh does or doesn't say at the next meeting.
• 14:55
  Ethan Powell: A-and by the way, we're floating rates, so it resets every three months.
• 14:58
  Ethan Powell: Even if there is rate volatility you're incorporating that relatively quickly.
• 15:03
  Ethan Powell: It's-- The asset class has a very low duration because of that.
• 15:06
  Ethan Powell: So that's why-- first and foremost, it's diversification.
• 15:10
  Ethan Powell: But to your point, you have a floating rate alternative income where, the nominal coupon on our portfolio is a little over eleven percent right now, right?
• 15:20
  Ethan Powell: So extremely juicy yield.
• 15:22
  Ethan Powell: And then if you look at that relative to corporate bonds, these are basically triple B rated, so it's a two to three hundred basis point premium over comparable quarter credit risk on the corporate side.
• 15:36
  Ethan Powell: So that's certainly appealing.
• 15:38
  Ethan Powell: And then, yeah, the diversification.
• 15:40
  Ethan Powell: I think the correlation of this asset class to high yield bonds, which is the closest correlation, the highest correlation, is still zero point zero one so almost no correlation which is really the bread and butter of the asset
• 15:54
  Ethan Powell: class.
• 15:55
  Ryan: Yeah,
• 15:56
  Ethan Powell: Yeah.
• 15:56
  Ryan: a very good point, Ethan, because as we know, and you said it, is when y- it hits the fan, everybody's running to the exits.
• 16:06
  Ryan: I don't care if you're in something that's, safe or perceived safe, like Everybody's running to cash, that's why correlations increase.
• 16:16
  Ryan: So you're exactly right.
• 16:18
  Ryan: Goods by, great example of a benefit there of cap bonds, because like you said, whether you like it or not, correlations increase when you need diversification most,
• 16:30
  Ethan Powell: Yeah.
• 16:30
  Ethan Powell: Yeah.
• 16:31
  Ryan: that
• 16:31
  Ethan Powell: this is the Adjusted for Risk podcast, so you wanna...
• 16:35
  Ryan: We-- I love talking about risk, Ethan.
• 16:37
  Ryan: Whenever we can
• 16:38
  Ethan Powell: Yeah.
• 16:38
  Ryan: in risk,
• 16:39
  Ethan Powell: yep.
• 16:39
  Ryan: I
• 16:40
  Ethan Powell: For sure
• 16:40
  Ryan: So let's talk too about more about risk, and you brought alternative bonds or just alternative private credit.
• 16:49
  Ryan: of the biggest issues there that we've realized is illiquidity or Risk.
• 16:54
  Ryan: We've realized that, yes, retail investors, they love alternative Or private credit.
• 17:01
  Ryan: Although we've realized in the past year they need liquidity.
• 17:06
  Ryan: Is-- How is liquidity catastrophic bonds?
• 17:09
  Ryan: I- is there a big risk there for liquidity?
• 17:14
  Ethan Powell: I, we...
• 17:14
  Ethan Powell: A, I'll just say cr- private credit, we love private credit as well.
• 17:17
  Ethan Powell: And for us, we think that it's a huge growth corner of the global capital markets, in part because banks con- increasingly are pulling back on, on providing creative and higher risk financing.
• 17:31
  Ethan Powell: You see a lot of the data centers and small to mi- middle market lending.
• 17:35
  Ethan Powell: I think the problem we have as a investing society is we say private credit, and it really is two dozen different types of credit and we just throw it all in the same bucket.
• 17:46
  Ethan Powell: And it tends to lead to frothy markets and potentially lower underwriting standards, which I think has led to some of the liquidity issues over the last year or so because it's a crowded trade in certain corners, right?
• 18:02
  Ethan Powell: A- as it relates to cat bonds, 'cause that wasn't your question, my thoughts on private credit But as it relates to cat bonds, our liquidity is really good, right?
• 18:10
  Ethan Powell: So couple things I would point.
• 18:13
  Ethan Powell: We're at $65 billion in the 144A cat bond market, which is what we're investing in.
• 18:18
  Ethan Powell: Our fund's $80 million, right?
• 18:21
  Ethan Powell: Certainly sufficient liquidity.
• 18:23
  Ethan Powell: I think we have 120 different bonds in the portfolio.
• 18:26
  Ethan Powell: We like to stay heavily diversified without any overweights to geographies or payrolls or sponsors.
• 18:31
  Ethan Powell: We like to l- look and feel like the broader market, basically.
• 18:35
  Ethan Powell: But what we've seen is the...
• 18:38
  Ethan Powell: we'll use our ETF liquidity as a proxy, right?
• 18:41
  Ethan Powell: 'Cause that's the market's perception of the underlying portfolio's liquidity.
• 18:45
  Ethan Powell: And our trailing 30-day median bid-ask spread is typically 10 basis points or less.
• 18:52
  Ethan Powell: So extremely tight given the non-correlated nature of this asset class.
• 18:58
  Ethan Powell: It...
• 18:59
  Ethan Powell: Because it's difficult to hedge, right?
• 19:00
  Ethan Powell: You look at these ETF market makers, they make a living off of making a lot of markets high volume, but then ultimately hedging whatever's on the balance sheet.
• 19:11
  Ethan Powell: And how do you hedge a diversified portfolio of earthquakes, wildfires, hurricanes, windstorms?
• 19:18
  Ethan Powell: There's no natural hedge against that.
• 19:21
  Ethan Powell: And so despite that our ETF has been tightly traded with pretty, pretty good volumes as well.
• 19:28
  Ethan Powell: I think we're 50,000 shares a day.
• 19:30
  Ethan Powell: So I think that's a good approximation for the underlying.
• 19:33
  Ethan Powell: We're deploying capital.
• 19:35
  Ethan Powell: A, a creation unit or two, we'll deploy it in a day or two, which is good.
• 19:39
  Ethan Powell: And we're very deliberate.
• 19:40
  Ethan Powell: We use a sub-advisor, Kingridge Capital, to actively manage the portfolio.
• 19:44
  Ethan Powell: They've got, decades of experience in this market.
• 19:47
  Ethan Powell: But Ryan, as liquidity is great until it's not, right?
• 19:50
  Ethan Powell: Look at '08.
• 19:51
  Ethan Powell: It's liquidity is ephemeral in every asset class.
• 19:55
  Ethan Powell: So I don't wanna make any forward-looking statements, but I can tell you our experience, it's been quite strong and getting better too.
• 20:02
  Ethan Powell: We're...
• 20:02
  Ethan Powell: Yeah, the cat bond, the 144A cat bond market is growing at a 10 to 15% annual rate.
• 20:09
  Ethan Powell: And we're hitting...
• 20:10
  Ethan Powell: We just hit a new issuance record last quarter.
• 20:13
  Ethan Powell: It seems every quarter we're hitting new records.
• 20:15
  Ethan Powell: It's good, getting better
• 20:17
  Ryan: Yeah.
• 20:17
  Ryan: So you have a lot of opportunities there.
• 20:20
  Ethan Powell: Yes.
• 20:21
  Ryan: not like it's limited.
• 20:22
  Ethan Powell: No, that's right.
• 20:23
  Ethan Powell: That's
• 20:24
  Ryan: Fantastic.
• 20:25
  Ethan Powell: right.
• 20:25
  Ethan Powell: And the other thing, Ryan, if you think about it, the 144A cat bond market, that's 60 billion, but the reinsurance market is 600 billion, right?
• 20:33
  Ethan Powell: And that's really very comparable risks, it's just packaged for institutions on the reinsurance side, and then when it comes down to the 144A, it makes it a little more accessible.
• 20:45
  Ethan Powell: So a ton of capacity and a ton of players in the marketplace to, pick up lowball bids in the event that there's a huge pullback
• 20:54
  Ryan: Yeah, great point.
• 20:55
  Ryan: And you've talked about risks or the benefits, a lot Up there.
• 21:01
  Ryan: The primary ones, like you said, low correlation to the other primary asset classes, the juicy yield.
• 21:08
  Ryan: We...
• 21:08
  Ryan: There's no free lunches, Ethan.
• 21:10
  Ryan: No free lunches in this space.
• 21:12
  Ryan: So what are some of the risks?
• 21:13
  Ryan: And you mentioned credit risk, like with insurers.
• 21:17
  Ryan: I'm assuming that might be a risk even though it's likely not gonna happen.
• 21:22
  Ryan: What are some risks out there
• 21:23
  Ethan Powell: It's funny you say that 'cause pre-'08 a lot of the cat bonds were basically these, privately negotiated bilateral agreements with insurers and reinsurers.
• 21:33
  Ethan Powell: And so in '08 a lot of people got stung on counterparty risk as insurers went under, right?
• 21:38
  Ethan Powell: However, post '08 that 65 billion that I'm quoting is fully cash collateralized, so it's bankruptcy remote, so truly no credit risk.
• 21:48
  Ethan Powell: If you go into some of the more esoteric sidecars, industry loss warrants, all these other different insurance-linked securities, yes, there's credit risk, but not in, in the corner of cat bond market that we're playing in.
• 22:01
  Ethan Powell: But going back to your point on risk the actuaries publi- publish expected losses on each of the bonds.
• 22:10
  Ethan Powell: So your average market expected loss is something like 2.5% to 3%.
• 22:17
  Ethan Powell: However, if you look at the actual results, it's...
• 22:22
  Ethan Powell: typically it's under 50 basis points of actual losses, right?
• 22:26
  Ethan Powell: What that expected loss really represents is actuarial assumptions under, as we talked about, 100-year flood type assumptions, right?
• 22:35
  Ethan Powell: I like to look at what the actual impairment rate has been, and it's significantly lower.
• 22:39
  Ethan Powell: But even if you look at the expected loss rate of 2.5%, the long-term high yield bond default rate is 3.5%, right?
• 22:47
  Ethan Powell: That might be a good comp.
• 22:49
  Ethan Powell: So still below high yield bonds and very much below as far as actual impairments go.
• 22:55
  Ethan Powell: So that would be the risk is of major natural disasters.
• 22:59
  Ethan Powell: And then, if you've seen the movie Armageddon, if something like that happens, your, your cat bond portfolio will get impaired pretty significantly.
• 23:07
  Ethan Powell: But theoretically we'll all have other things to worry about
• 23:10
  Ryan: Yeah.
• 23:10
  Ryan: Exactly.
• 23:11
  Ryan: I've got a lot of things to worry about.
• 23:13
  Ryan: That one really isn't one, Ethan, but it's lower on my list.
• 23:17
  Ethan Powell: Yes.
• 23:18
  Ryan: doesn't rise.
• 23:19
  Ryan: Hopefully it doesn't rise.
• 23:20
  Ethan Powell: No, it's-- No shit
• 23:21
  Ryan: And you mentioned it, so a lot...
• 23:24
  Ryan: You've compared cat bonds to the high-yield bond space, bit there to insurance-linked securities, ABSs.
• 23:33
  Ryan: Is there any other differences you'd like to highlight between the more, know, mainstream bond types?
• 23:41
  Ethan Powell: I would love to get our cat bond portfolio into an ABS because there you're talking about really structuring risk return appetite for a broader set of potential investors.
• 23:53
  Ethan Powell: And I think the non-correlated nature of the asset class is well suited for an ABS.
• 23:57
  Ethan Powell: Obviously with ABS you're dealing with structural risk.
• 24:00
  Ethan Powell: A lot of the risk is passed down to the equity tranche and more junior tranches.
• 24:04
  Ethan Powell: I think I mentioned on a relative, generally the broader cat bond market is viewed as sort of a triple B risk.
• 24:12
  Ethan Powell: And so it's trading at a premium to 2 to 300 basis point yield premium to comparable credit risk.
• 24:21
  Ethan Powell: Which I think is on a standalone measure is very attractive.
• 24:26
  Ethan Powell: But no, yeah, I think it's just a very nuanced asset class and like I said, it's an alternative and, you get risk-adjusted returns because of the intrinsic nature of the risk you're assuming, not because you're expecting the manager
• 24:39
  Ethan Powell: to, like a long-short equity to go all short when the market's down and all long when the market's up.
• 24:45
  Ethan Powell: That takes a special kind of skill that I don't think many people, if anyone, has.
• 24:49
  Ethan Powell: And then you have a lot of these structured s- sort of financial engineering products like buffered ETFs for example, that provide some downside protection, but they haven't really been tested.
• 25:00
  Ethan Powell: This asset class has been tested since inception of the Swiss Re index.
• 25:05
  Ethan Powell: There's only been one down year, and that was 2022, and it was 2%, right?
• 25:09
  Ethan Powell: You're talking about a very resilient asset class that yeah that I think will continue to shine during periods of market volatility
• 25:18
  Ryan: Ethan, we could have a whole conversation about buffer products, and I'm so glad you brought that up.
• 25:25
  Ryan: And that, cat bonds, you can go back, they've gone through historical records through market cycles.
• 25:34
  Ryan: You can look back, see how they performed during market cycles.
• 25:39
  Ryan: products, it's easy to launch all these new products.
• 25:42
  Ryan: When markets keep ripping higher, of course they look good.
• 25:47
  Ryan: see how they perform when we go through a full market cycle and we're down 20% and there's a bear market.
• 25:53
  Ethan Powell: Yeah.
• 25:54
  Ethan Powell: Yeah.
• 25:54
  Ryan: seen there.
• 25:55
  Ryan: Glad
• 25:55
  Ethan Powell: Yep.
• 25:55
  Ryan: up.
• 25:56
  Ethan Powell: Totally agree.
• 25:57
  Ethan Powell: Yeah.
• 25:58
  Ryan: another conversation.
• 25:59
  Ryan: So real quickly then, what role do they play in investment portfolios?
• 26:04
  Ryan: Kind of the million-dollar question here.
• 26:06
  Ryan: Is it a core fixed income holding, or is it something more of a thematical play?
• 26:12
  Ethan Powell: Yeah, what we see advisors how they position it within their clients' portfolios primarily as a satellite alternative income play, right?
• 26:21
  Ethan Powell: We have some great charts speaking of risk-adjusted return that the risk-adjusted return of a otherwise diversified portfolio, if you replace bonds with it, it increases obviously the return and the yield significantly without impacting volatility or risk.
• 26:38
  Ethan Powell: And then similarly with equity you can significantly reduce the volatility while not sacrificing return.
• 26:45
  Ethan Powell: That's I think how a lot of advisors position it as a alternative income bond allocation.
• 26:52
  Ethan Powell: But it's typically satellite.
• 26:54
  Ethan Powell: I think your standard advisor isn't gonna put 40% of their client's portfolio in, in cat bonds.
• 27:03
  Ethan Powell: But, certainly...
• 27:04
  Ethan Powell: and we see it in a lot of model ETF portfolios as well where they can allocate a, a good chunk to it a- and then get, in- investors in different ways.
• 27:13
  Ethan Powell: And that's also how we see our institutional accounts allocating to it as well.
• 27:18
  Ethan Powell: Non-correlated premium income allocation.
• 27:22
  Ryan: Yeah, I think that's a very prudent approach to that portfolio question.
• 27:27
  Ryan: So then lastly, you mentioned it earlier, the ticker, but how can financial advisors incorporate the investment strategy in their clients' portfolios?
• 27:36
  Ryan: Where can they start?
• 27:38
  Ethan Powell: Yeah.
• 27:38
  Ethan Powell: We're traded as an ETF, so it's ticker ILS for insurance-linked securities.
• 27:43
  Ethan Powell: It's the Brookmont cat bond ETF.
• 27:46
  Ethan Powell: We're on most brokerage and open architecture platforms.
• 27:49
  Ethan Powell: If you do work at a wirehouse, please tell your home office to call us and we're happy to get added there, too.
• 27:55
  Ethan Powell: But we've had about a year and a half of performance.
• 27:59
  Ethan Powell: We've got 80 million in the portfolio yeah, access it via ticker ILS.
• 28:03
  Ethan Powell: And feel free to go...
• 28:05
  Ethan Powell: We have ILS inve- or catbondinvesting.com, which is an educational site, and then ilsetf.com is the ETF site
• 28:16
  Ryan: Fantastic.
• 28:16
  Ryan: I went to those website.
• 28:18
  Ryan: Ethan, some people may disagree with this, but I do a little bit of research before jumping on these calls, so I did go to the website to learn some more.
• 28:27
  Ryan: Great information.
• 28:28
  Ryan: Lot of good education there for people that want a little bit more information on the asset class.
• 28:35
  Ryan: So lastly, thank you so much, Ethan, for coming on.
• 28:38
  Ryan: Really fun conversation, important conversation, lot of great insights, so I really appreciate it.
• 28:45
  Ethan Powell: Thank you
• 28:45
  Ryan: get more information about Brookmont?
• 28:48
  Ethan Powell: We also have a advisor website brookmont.com as well.
• 28:52
  Ethan Powell: And there, there's info and feel free to email if...
• 28:56
  Ethan Powell: and, one of the things we pride ourselves in being very accessible because we recognize you can't turn on CNBC and get your cat bond update.
• 29:04
  Ethan Powell: If you wanna continue the conversation, I really encourage you to reach out via the website and we can schedule a call
• 29:10
  Ryan: Fantastic.
• 29:11
  Ryan: Ethan, thank you again so much.
• 29:13
  Ryan: Fun conversation.
• 29:14
  Ryan: Stay cool down there in Dallas.
• 29:17
  Ryan: Hopefully you've got a pool.
• 29:18
  Ryan: Hopefully you got a pool to hang out in with to have some cold
• 29:22
  Ethan Powell: to visit you in Tahoe though, so
• 29:24
  Ryan: Yeah, it- s- I'll take 75 degrees every day.
• 29:28
  Ethan Powell: Oh yeah
• 29:29
  Ryan: So don't feel bad for me, Ethan.
• 29:31
  Ethan Powell: No, I won't.
• 29:32
  Ethan Powell: It's 1:05 here, so that's fine.
• 29:34
  Ryan: Yeah, there we go.
• 29:35
  Ryan: Awesome, Ethan.
• 29:36
  Ryan: Thank you, and thank you everyone for listening to this episode.
• 29:40
  Ryan: You can watch all of our other episodes on YouTube and Spotify and wherever else you catch your favorite podcasts.
• 29:46
  Ryan: Please be sure to like and subscribe to those channels and give us a follow on LinkedIn.
• 29:51
  Ryan: you very much and have a great rest of your week