The U.S. ETF industry has its first fund exclusively focused on catastrophe bonds.

Brookmont Capital Management launched the Brookmont Catastrophic Bond ETF (NYSE:ILS), providing investors with a new method of exposure to this $50 billion sector. But there’s a huge catch—it’s debuting without a lead market maker, a rare decision that may impact trading.

Cat bonds, or catastrophe bonds, are special securities issued by insurers, reinsurers, and governments to assume financial risks of colossal natural disasters such as hurricanes, wildfires, and earthquakes. Investors who purchase these bonds earn floating-rate returns—usually in the low teens—backed by insurance premiums. Because the bonds are fully cash-collateralized, they have little or no counterparty risk.

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Brookmont’s new ETF makes it easier to access this sophisticated asset class. “ILS delivers a low-correlation, high-yield alternative to traditional bonds at a time when investors are seeking new sources of income and diversification,” stated Ethan Powell, Brookmont Capital Management Principal & Chief Investment Officer.

In contrast to other investment plans that package Cat bonds with perils such as cyberattacks or terrorism, this ETF is exclusive to natural disaster-linked bonds. The intention is to give investors pure-play exposure to an asset class that is driven by unforeseen climate-related events.

The Increasing Demand For Cat Bonds

The catastrophe bond market is expanding rapidly. Issuance in the first quarter of the year reached $7.1 billion, one of the busiest quarters in the history of the market, per Artemis data. With climate-related disasters increasing in frequency and severity, insurers feel compelled to seek new means of managing their risk.

“The insurance industry is under immense pressure to manage growing losses from natural disasters,” commented Rick Pagnani, co-founder of King Ridge Capital Advisors, the sub-adviser to the ETF. “Cat bonds have become an essential tool for strengthening the insurance ecosystem and, with the robust growth and maturation of this market, we believe ILS will play a role in catalyzing that growth.”

Brookmont expects the Cat bond market to exceed $80 billion by the end of the decade as demand increases among insurers and investors.

A Pioneering ETF Launch Without A Lead Market Maker

Innovative structure or not, the ILS ETF is debuting without a lead market maker (LMM) team—firms usually responsible for facilitating smooth trading by quoting buy and sell prices. The absence is a novelty among the $10 trillion U.S. ETF market.

“In an esoteric asset class such as catastrophe bonds where traditional ETF market makers don't know how to price the risk, there's reluctance to be on the hook from a statutory perspective,” Powell told Bloomberg.

Without an LMM, the fund may suffer from liquidity issues, such as wider bid-ask spreads and less liquid trading. Certain niche ETFs, such as the X-Square Municipal Income ETF (NYSE:ZTAX), have seen bid-ask spreads reach $2.25, whereas a traditional fund such as the SPDR S&P 500 ETF (SPY) only has a bid-ask spread of $0.01, noted Bloomberg in a report.

Brookmont’s Faith In The ETF’s Future

In spite of the unorthodox debut, Powell is hopeful. The ETF has six approved participants (APs) waiting in the wings to assist in keeping its price near the value of its underlying assets. Bloomberg cited Powell saying, “They're all super interested in the product and they're excited to make a market in it, they just don't want to be on the hook if things go wide.”

As the fund picks up steam, Powell expects an LMM to ultimately step in. In the meantime, investors will be closely observing how this first-of-its-kind ETF handles the intricacies of catastrophe bond trading in the open market.

Whether it turns out to be a game-changer or a liquidity problem waiting to happen, the ILS ETF represents another ambitious experiment in the constantly changing ETF space.

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