Longer-term investors to drive the shape of the ILS market

Panelists speaking at the ILS Bermuda Convergence 2015 event in Bermuda yesterday discussed the investor base, how it has changed and will change further going forwards, concluding that it is investors with a longer-term horizon that will shape the ILS market.

Insurance-linked securities (ILS) and reinsurance investors are becoming increasingly sophisticated, as large institutions such as pension funds come into the space with a view to making it a core alternative asset class for them.

The benefits of diversification and low-correlation still stand, but investors are facing a challenging investment environment, where alternatives to ILS look very weak by comparison, despite the decline in reinsurance and catastrophe bond rates.

Tony Rettino, Founding Principal and Portfolio Manager at ILS investment specialist Elementum Advisors, explained that the asset class is most suited to investors looking for a longer-term play, with the large institutions of the world most likely to stick with and shape the future of ILS.

“I think the longer-term investors will tend to drive the way the market is shaped, just because the longer term more strategic nature of their allocation process is going to have more of an impact than people who are in in a more temporal way,” he commented.

Adding that; “I think we have seen a recycling of the investor base, but I don’t think it’s fundamentally changing in terms of their objectives. Fundamentally the longer-term capital will remain the driver.”

Jon Seo, Co-Founder and Managing Principal at cat bond and ILS specialist investment manager Fermat Capital Management LLC, said that he feels the current state of the macro investment rate environment has an impact on the make-up of the  ILS investor base.

“Lower rate environment you’re going to have a different source of capital,” Seo explained.

“I’m seeing investors re-orienting themselves. They want to have something that’s disconnected with the rest of the market, not necessarily for a classic portfolio diversification play but because they just don’t really have any confidence or conviction in other things they are doing,” he continued.

This lack of confidence and conviction in the broader asset classes of the world is an opportunity for the ILS sector to attract more long-term investors. With many already aware of ILS, Seo suggests that a steady flow of capital will be attracted to the market while the alternatives to ILS look weak.

“They do want the option to move their money if they see an opportunity in a market that they have knowledge for. They’re really looking to park their money in something that they feel has a reasonable tail-wind to it, but a lot of it’s that they don’t have a lot of conviction elsewhere,” he said.

Seo went on to say that it’s a “pretty low bar out there” in terms of other comparable asset classes, such as liquid alternatives, which is helping to keep ILS attractive to investors.

In terms of the potential for future growth, while all the panelists certainly agreed that growth is certain the rate is less certain and comes down to factors often outside of the markets control.

Paschal Brooks, Portfolio Manager at AlphaCat Managers Ltd. the ILS unit of reinsurance firm Validus, said further growth is to be expected, particularly while no impactful events have occurred.

“I think we’re looking at more steady, continuous growth,” he explained. “The issue now is not so much getting people’s attention, or making reinsurance get headlines in terms of being an asset class opportunity. I think there are fairly deep penetration in terms of knowledge about the asset class.”

“It’s more about increasing acceptance and institutional investors adding it as a portion of their portfolio over time,” he added.

Brooks went on to say that recent growth of billions per year, largely in collateralised reinsurance, may be hard to replicate but that inflows are expected to continue.

Seo then said that while collateralised reinsurance has outgrown catastrophe bonds in recent years, becoming the major portion of the ILS market, he expects that growth between the two sides of the asset class will likely even out.

He went on to discuss new versus existing investors in ILS, saying that he expects that a big “investor rotation” will happen, largely due to the rate dynamic.

“New investors in this lower rate environment, I think they’re going to be equally committed and I think that the scale of the commitment is actually going to be larger,” Seo explained.

Seo said that when the rates get down to this lower level the “candidate investor base actually explodes” as there are more large investors looking for lower, stable returns from the institutional and pension investor base for whom the asset class is becoming increasingly suitable.

As the investor base changes and more long-term capital comes into the ILS market it will also increase in sophistication, as these investors typically want to gain an understanding of the asset classes they allocate to.

A more sophisticated, long-term institutional investor base is good for the market, providing opportunities for managers and cedents to put capital to work, perhaps in new ways.