Losses an opportunity to assess ILS fund manager performance

When this year’s major hurricane losses struck the insurance-linked securities (ILS) market, the last thing on most investors minds was the relative performance of their investment managers. But now, with the picture of the eventual loss clearing, many ILS investors will for the first time be able to compare their ILS manager with others in the market.

But comparisons are not as simple as they may seem, with ILS managers having their own views of risk, their own risk model calibration, and portfolios that are often differentiated through risk appetite, their relationships with cedents and how good their access to business is.

Also size matters, as ILS funds with more assets under management will typically have a much broader portfolio of insurance and reinsurance risk, in terms of the number of contracts underwritten and invested in.

Strategy and structure also matters, as some ILS funds that utilise leverage (often from their parent or sponsoring insurance or reinsurance entities balance-sheet) can access many more underwriting opportunities, resulting in portfolios that can have significantly more, often smaller, ILS investment positions.

The differences in size,strategy and structure mean ILS funds can face entirely different levels of volatility from catastrophe loss events, which we’ve seen in the significant spread between ILS fund performance in September and October’s results.

ILS Advisers recently reported that it saw a massive gulf between best and worst performing ILS fund of 26.73% in September.

The gap between strategies was also stark in September, with pure catastrophe bond funds down -4.66%  for the month, but the ILS funds that invest in private ILS and collateralized reinsurance dropping -12.11%.

However, despite the gulf in performance there is now an opportunity for investors to gain some insight into how different ILS fund managers and different ILS strategies have performed through the recent catastrophe losses.

The 2017 catastrophes have provided a robust test for the ILS market, with a number of major losses all occurring within quick succession and the key market juncture of the January reinsurance renewals just around the corner.

For many investors this will be their first chance to see how ILS fund managers handle marking down positions, dealing with uncertainty over loss estimates, handling actual losses and paying their claims, all while continuing to trade forwards, raise capital and manage the rest of their investment portfolios.

Importantly this is without a doubt the first test for the ILS fund market where collateral is set to be trapped at a key renewal. This has never occurred in the roughly twenty years of the ILS market, so is a new experience for all managers and therefore a prime opportunity for investors to ensure they are comfortable with collateral reserving, reporting and releasing practices.

Chris Arcari, an Investment Research Associate Consultant at independent investment consultants Hymans Robertson, commented on this in a recent report.

“The conclusions to be drawn from one year cannot be comprehensive, but large industry losses in 2017 will provide an opportunity to assess how managers have performed in respect of risk control relative to their stated objectives and diversification beyond the US wind risk that dominates the market,” Arcari said.

Thus far, while there are clear differences in performance following the third-quarter catastrophe losses, there is little to be surprised about in ILS fund performance, suggesting that results have been roughly aligned with ILS manager strategies and structures.

It’s a little harder to look-through to reinsurer sidecars, where significant losses have been experienced, but again our sources suggest that there is little that was not expected here either.

Of course, the real performance of ILS funds through these losses and their ongoing management of claims and reserving, as well as how they deal with trapped collateral, will not become clear for some months to come. The California wildfires are set to exacerbate the issues, with further declines for some ILS funds expected as a result.

Arcari continued, saying that while recent months have made it clear that ILS investments “carry their own risks” the experience does not seem to have dampened investor demand.

“The tragic events of this year will not reduce the demand for insurance; indeed, they emphasise the value that it can have,” he explained. “Tighter supply of capital may mean that those willing to supply it may get a more attractive entry point for investment in the ILS market.”

Right now investors are not just focusing on how ILS fund managers have performed, but also on who will perform best going forwards based on the opportunities that the current market supplies.

Join us in New York in February 2018 for our next ILS conference