Cat bond price compression leads to low ILS fund returns in May

The average return of the insurance-linked securities (ILS), reinsurance linked investment and pure catastrophe bond fund market sank to a new low for 2014 of just 0.09% in May, according to the latest data from the Eurekahedge ILS Advisers Index.

The group of pure catastrophe bond funds tracked by the index saw their first negative month of the year, as price compression on secondary market cat bonds weighed on fund performance for the month. The impact of cat bond price compression was felt more broadly across the ILS fund market, resulting in the low monthly performance.

The 0.09% returned in May is the lowest monthly return of the Index since last June and demonstrates the way market dynamics work in ILS, when high amounts of capital pour in to soak up record levels of new deal issuance.

The strong inflows of capital which flowed into the ILS sector in April and May continued to compress the ILS and cat bond markets spread in May, according to ILS Advisers.

While the ILS Advisers Index was positive in May the cat bond market as measured by the Swiss Re indices saw a negative month of -0.83% for the price return index and -0.25% for the total return index. As a result of this negative cat bond performance the broader ILS market suffered, but the overall positive return of the Index shows the advantages of a balanced strategy across cat bonds and private ILS or collateralized reinsurance.

The performance of the market in May shows investors that this market will see price fluctuation dependent on activity and interest, as with any other asset class and it is not just catastrophes that can impact a months return. Catastrophe losses in May remained relatively benign.

For cat bonds, the huge supply seen year to date, the previous appreciation of bond prices and the onset of seasonality on U.S. wind bonds combined to take the prices down. According to ILS Advisers, prices on U.S. wind bonds dropped by around 0.8% right before the beginning of the U.S. hurricane season. Cat bonds are expected to pick up some momentum again as the hurricane season develops and seasonal pricing effects kick in.

Also demonstrating the difference in strategies in ILS investment and how one ILS fund can outperform while another suffers, depending on assets in the portfolio, the difference between the best and worst performing ILS fund in May was 1.65%, a wider gap than in April.

The subgroup of pure cat bond funds saw a negative return of -0.1% in May, while the group that also invest in private ILS saw a positive return of 0.25%. In total, 14 of the 34 funds tracked by the ILS Advisers Index saw a positive return in May, while 20 saw a negative return for the month.

Recent performance for the Index has been driven by market dynamics, resulting in the slower performance and lower return. As ILS Advisers said, this should change in time as seasonal effects on pricing boost performance through the wind season. It will be interesting to see how the Index performs should a hurricane threaten a major loss this year.

Eurekahedge ILS Advisers Index – Tracking the average performance of 34 ILS funds (click the image for more details)

You can track the Eurekahedge ILS Advisers Index on Artemis here including the new USD hedged version of the index. It comprises an equally weighted index of 34 constituent ILS funds which tracks their performance and is the first benchmark that allows a comparison between different insurance-linked securities fund managers in the ILS, reinsurance-linked and catastrophe bond investment space.