Catastrophe Bond Fund Guide: Evaluating a Growing Asset Class

Catastrophe bonds, or cat bonds, have attracted growing investor interest by offering the potential for higher returns and diversification through exposure to catastrophe risk. While the asset class has delivered compelling performance, the market remains complex and capacity-constrained.

Morningstar’s Catastrophe Bond Fund Landscape report examines the global cat bond and insurance-linked securities, or ILS, fund universe, including the trade-offs, opportunities, and performance trends. To better evaluate opportunities and manage risk, asset managers must understand these dynamics.

Download the full report.

Cat bonds emerged in the late 1990s after Hurricanes Andrew and Hugo and the Northridge Earthquake left insurers and reinsurers struggling to cover massive losses. The industry sought new ways to shift catastrophe risk losses onto investors instead of relying solely on traditional reinsurance.

To transfer this risk, an insurer or reinsurer issues a cat bond, and the money raised is placed in a reserve fund. Investors earn regular coupon payments, but if a specified disaster occurs and hits a preset trigger, some or all of their principal may be used to cover the claims. If no qualifying disaster occurs during the bond's term, investors get their principal back in full, plus interest.

Cat bonds offer higher potential yields in exchange for catastrophe risk and can provide diversification, since natural disaster risk tends to move independently of typical stock and bond market fluctuations.

• Wind events, including tornadoes and hurricanes
• Earthquakes
• Winter storms

Other perils, such as wildfires and floods, are becoming a more significant part of the cat bond market as insurance companies seek protection against losses from them.

The primary risk of a cat bond is that a specified catastrophic event could occur, causing investors to lose a significant portion of their principal investment.

Beyond event risk, additional challenges include:

• Model risk: Inaccurate catastrophe predictions may lead to potential misjudgment of risk exposure.
• Liquidity and price discovery risk: Observed market prices may differ significantly from the underlying value of cat bonds due to the thinly traded nature of the market.
• Concentration risk: Individual cat bonds can suffer principal write-downs based on idiosyncratic events, making portfolios concentrated in a single peril or region more vulnerable than diversified ones.
• Interest rate risk: The risk of cat bonds’ valuations moving with changes in underlying long-term yields is low. Over the trailing 10 years, the SwissRe Cat Bond Index has a correlation of 0.17 versus the 10-year US Treasury yield.
• Counterparty risk: If the issuer of the bond becomes financially unstable, it could affect its ability to pay claims in the event of a catastrophe.

As of the end of June 2026, Morningstar identified 43 investment vehicles dedicated to the insurance-linked market globally, representing USD 37.7 billion of assets under management. That’s up more than 70% from USD 22 billion in June 2023.

Over the past three years, catastrophe and ILS funds brought in USD 10.2 billion of net new money, with strong performance driving additional asset growth.

The universe is very top-heavy: The top 10 funds account for 75% of the assets, and a handful of players—Twelve Capital, Stone Ridge, Schroders, Fermat, and GAM—dominate the field.

Capacity is a critical concern as well. Given the thin secondary market for cat bonds, two of the top three largest funds, Twelve Cat Bond and Schroder GAIA Cat Bond, are currently closed to new investors after having reached internally defined capacity limits. Most cat bond vehicles also offer less frequent liquidity (weekly or monthly) than traditional fixed-income investments.

Although information on the cat bond market is becoming more widely available, measuring the added value of active management remains difficult. Most strategies are fairly buy-and-hold in nature and source the vast majority of their investments in the primary market, as secondary trading is usually expensive to execute.

As funds grow, portfolios may look more like the broader cat bond market. Some managers seek differentiation through specialized expertise or exposure to non-natural perils such as cybersecurity and terrorism, but these are in the minority.

Over the five-year period ended June 2026, the median cat bond fund delivered a 6.7% annualized net return, outperforming traditional bond counterparts such as the Morningstar Global Core Bond Index and the Morningstar US High Yield Bond Index.

Additionally, cat bonds have delivered significantly lower volatility than traditional bond markets. In 2022, for example, the median cat bond fund lost 3.5%, while most global bond funds posted double-digit losses.

But comparing peer group returns with the Swiss Re Global Cat Bond Index, a more representative benchmark for the asset class, provides a more sobering view: Over the same period, the median fund lagged the index by almost 400 basis points annualized.

As interest in cat bond funds continues to grow, asset managers need a clear understanding of the benefits and risks shaping the space. 

Analyze fund universes, compare strategies, and support due diligence in one comprehensive application with Morningstar Direct.