Stone Ridge sets up ILS fund for ‘Post-Event’ reinsurance investments

Stone Ridge Asset Management is launching a new insurance and reinsurance linked securities (ILS) fund, with a strategy focused on providing investors a way to capitalise on opportunities after large catastrophic events cause market dislocation.

New York based Stone Ridge Asset Management, the beta, alternative risk and reinsurance focused mutual fund manager, has grown its insurance-linked securities (ILS), catastrophe bond and reinsurance linked assets under management rapidly to reach $3.713 billion by the end of July 2015.

The asset manager has been forward thinking both in terms of sourcing capital through its mutual fund platforms via registered investment advisors and also with fund structures, being the first to launch an interval fund, which is now Stone Ridge’s largest at $2.22 billion.

Now Stone Ridge is launching a new fund strategy, called the Stone Ridge Post-Event Reinsurance Fund, a newly formed closed-end investment fund registered under the Investment Company Act of 1940 (40’s Act).

As you might guess from the fund’s name, Stone Ridge has spotted an opportunity to help investors to gain easier access to the returns of the reinsurance and ILS market after a major catastrophe loss event, perhaps at the same time helping its own fund liquidity.

Although there has been a lot of discussion about the reinsurance cycle being flattened and that rates may not spike as much as before when major catastrophe events occur, Stone Ridge still believes that post-event there will be opportunities for investors to take advantage of higher rates or market dislocation.

A prospectus for the newly formed Stone Ridge Post-Event Reinsurance Fund, published today, explains:

After a catastrophic insured loss event, particularly in the U.S., the reinsurance industry will have to pay out a significant amount of capital and will, therefore, have less capital available to underwrite risks in the immediately following years.

Having access to stable, long-term capital, especially after a catastrophically large loss, is a key concern for reinsurers and, therefore, a potential opportunity for investors.

The Fund is intended to serve as a vehicle to allow investors to maintain or grow their exposure to the reinsurance asset class at such time.

The interesting part of the strategy is that Stone Ridge does not intend to sell shares immediately in the fund, but says that it will being offering shares in the Post-Event fund if ” the Reinsurance Interval Fund experiences a material drawdown.”

So essentially Stone Ridge’s prospectus for the Post-Event Reinsurance Fund says that investment operations will begin only when its existing Interval fund faces a major catastrophe loss event, which results in a big drawdown of capital in order to pay losses. Stone Ridge notes that such a loss is likely to be a U.S. catastrophe event, but could also be from outside the U.S.

Once such an event occurred the Post-Event Reinsurance Fund will operate by investing substantially all of its assets in the Stone Ridge Reinsurance Risk Premium Interval Fund, so acting as a feeder to recapitalise the Interval fund at a time when it faced a large draw down and following its strategy.

This could help Stone Ridge to bring new capital in at a time when existing investor capital might be tied up, due to loss payments being determined, enabling Stone Ridge to ensure it can access capital to take advantage of the opportunities that emerge in reinsurance market and private ILS transactions.

Remember that Stone Ridge’s Interval fund is its least liquid strategy, so featuring investments in collateralized reinsurance sidecars, private ILS deals, segregated cell transactions and other structures, many of which post-event will find collateral locked up for some time. It also has some capital deployed into more liquid cat bonds and Treasuries, to provide some liquidity. A source of capital that can help the fund to continue operating and deploy into new and perhaps more attractive post-event opportunities could therefore be highly beneficial.

This could be particularly important if the reinsurance cycle has been structurally changed by new capital and ILS’ entry into the space. Many expect the cycle to be flatter, but also for the payback post-event to only last a renewal or two, rather than a number of years.

That means gaining access to new capital rapidly to take advantage of any higher priced opportunities that emerge could be vital for both investment managers and for the end-investors as well. With the launch of the Stone Ridge Post-Event Reinsurance Fund the asset manager seems to be trying to ensure it can capitalise on market dislocation and post-event rate rises.

It seems from the prospectus that at the point the Post-Event fund begins operations, so after a catastrophe event, the Interval fund is likely to be closed to investor subscriptions, so the Post-Event fund can assure some continued access to new capital for the fund in the wake of a draw-down.

Also noteworthy is the fact that a year following activation due to a catastrophe event the Post-Event Reinsurance Fund would be folded into the Interval fund, subject to advice from the adviser.

There is also an allowance for a the Post-Event fund to be made available to a ‘Consortium’ of investment advisors, RIA’s who can invest on behalf of clients, on a priority basis after a major event has occurred. This would allow Stone Ridge to ensure that large and important investors it has built a relationship with will have access to its strategies even after a market dislocating catastrophe event.

As a mechanism to provide investors with a way to maintain or grow their allocations to ILS and reinsurance linked investments at a time of a large catastrophe loss, when risk capital will be in demand and pricing likely higher, Stone Ridge’s Post-Event fund seems a sound strategy.

Whether the manager could choose to raise money into the fund pre-catastrophe, perhaps investing it in liquid Treasuries, but with the ability to sell those as soon as a catastrophe occurs to reinvest into its Interval fund is not as clear, but perhaps also an option.

It’s another interesting ILS investment strategy from Stone Ridge which is sure to get the market talking again. Perhaps it will also get other ILS managers thinking about how they could provide structures that would allow some of the fabled “investors on the sidelines” to get into the market quickly and at the right (post-event) time.