During periods of market stress, waves of selling are typically triggered by balance-sheet constraints, funding pressures, and forced deleveraging. Because of this, investors often presume that catastrophe bonds, particularly in an ETF format, will mimic high-yield credit during a macro crisis, experiencing the same indiscriminate selling and liquidity breakdowns.
Recall in late December 2025, King Ridge Capital Advisors launched its UCITS exchange traded catastrophe bond fund (ETF) in partnership with UCITS ETF white-label platform provider HANetf, with London-based specialist Goldenberg Hehmeyer LLP (GHCO), as its designated lead market maker.
As we said at the time, the KRC Cat Bond UCITS ETF fund, which trades under a ticker symbol of CATB, marked the first catastrophe bond fund ever to have a designated lead market maker in place from its launch.
In the paper, Pagnani notes that while cat bond ETFs have not yet weathered a full stress cycle since their recent introduction, historical data from the underlying catastrophe bond market provides a clear framework for predicting how these ETFs will behave.
“Historically, stress in cat bonds has remained orderly when three features are present: no leverage, diversification that localizes event uncertainty, and transparency that lets market participants separate affected from unaffected risk. These features stand in sharp contrast to the structural drivers of deleveraging in high yield credit markets and help explain why catastrophe bonds have historically exhibited lower sensitivity to macro driven forced selling dynamics than many leveraged credit markets,” the paper reads.
The CEO also highlights how catastrophe bond ETFs invest exclusively in publicly issued catastrophe bonds and explicitly exclude private reinsurance arrangements such as sidecars and quota shares.
“At the fund level, catastrophe bond ETFs operate without leverage, margining, or financing linked to market prices. Creations and redemptions may be processed in cash, but the ability to redeem in kind provides an important additional tool: the fund can meet outflows by delivering a pro rata basket of bonds rather than selling bonds into the secondary market during periods of elevated spreads. This can help limit stress driven transaction costs and helps keep event uncertainty from turning into mechanically forced selling. Volatility is therefore expressed primarily through price adjustment rather than balance sheet driven distress,” Pagnani noted.
Breaking down the components of cat bond returns further clarifies their resilience during crises. The paper points to coupon carry as a historical stabiliser due to its contractual income nature, noting that realised losses are typically discrete and strictly bounded.
Crucially, while macro uncertainty does transmit into cat bond prices during a crisis, that risk remains insulated within portfolios through diversification across peril, geography, and attachment points
“Well constructed catastrophe bond portfolios localize event uncertainty to the subset of potentially affected bonds rather than allowing it to propagate across the entire portfolio,” the paper reads.
The paper also adds how investor and market-maker transparency plays an equally vital role. Public cat bonds rely on standardised documentation, defined triggers, observable attachment points, and fully funded collateral, allowing market participants to calculate exact exposures even mid-crisis.
This transparency ultimately reduces adverse selection risk (i.e., the risk of trading disproportionately with better informed sellers), supporting more continuous price discovery and helping authorised participants evaluate and hedge creation/redemption baskets during stress.
“Bid ask spreads provide a direct lens into how uncertainty, diversification, and transparency show up in market microstructure. Under normal conditions, catastrophe bond ETFs have traded with relatively tight average bid ask spreads, while the underlying catastrophe bond market has historically exhibited wider but orderly spreads. During periods of elevated uncertainty surrounding major hurricanes, spreads have widened in a bounded and selective manner: directly exposed bonds trade wider, while bonds outside the affected region or attachment layer remain closer to baseline,” the paper adds.
Data in the paper illustrating bid-ask spread distributions across hurricane stress phases, showcases how the widening is asymmetric. According to Pagnani, this indicates that uncertainty is being efficiently priced into the market, rather than signaling a systemic breakdown in market functionality.
Addressing historical precedents, Pagnani clarifies that the isolated gating events seen in 2017 did not reflect systemic flaws in public cat bonds. While secondary market liquidity for public bonds remained functional, the gating issues were actually driven by fund-level liquidity terms and heavy exposure to private reinsurance contracts, which suffer from long-dated, indemnity-based settlement timelines.
“This distinction highlights the difference between market liquidity and fund level liquidity. Pure play catastrophe bond ETFs that invest exclusively in publicly issued catastrophe bonds may reduce exposure to trapped capital and extended uncertainty associated with private reinsurance. Emphasizing transparency, diversification, and tradability can help mitigate liquidity risk that arises from asset –liability mismatches during stress events,” Pagnani noted.
To conclude, the CEO acknowledges how catastrophe bond ETFs are often misinterpreted through analogies drawn from leveraged credit markets.
“While hurricanes introduce uncertainty and volatility, they do not typically activate the structural mechanisms responsible for forced selling. The analysis in this paper indicates that catastrophe bonds have tended to reprice under stress without entering deleveraging regimes. Drawdowns have tended to be shallow, bounded, and mean reverting, consistent with the absence of binding balance sheet constraints in the asset class.
“One implication for portfolio construction follows from this distinction. Catastrophe bonds are not crisis immune, and they may be less exposed than many leveraged credit instruments to deleveraging driven selling dynamics.
“In an environment where forced selling increasingly shapes market outcomes, this structural difference can be more consequential than correlation alone. Taken together, the evidence in this paper indicates that resilience to deleveraging in catastrophe bond ETFs is conditioned on three reinforcing structural features: no leverage, diversification that localizes event uncertainty, and transparency that lets market participants separate affected from unaffected risk. Properly constructed pure play catastrophe bond ETFs may provide a differentiated combination of income, diversification, and structural resilience—penalizing uncertainty temporarily while rewarding patience through information resolution,” Pagnani concludes.
