The BBC, or British Broadcasting Corporation, pension fund made a £76m allocation to insurance-linked securities and catastrophe bonds through an investment mandate given to Nephila Capital las year (read our article on the original allocation of funds here). While the investment is small, at less than 1% of the BBC pension funds total assets of over £8 billion, and has only made the BBC a marginal return to date they do appreciate the diversification properties within the asset class.
The recently published report on Insurance Linked Securities (ILS) from independent publisher Clear Path Analysis contains a roundtable interview which includes the James Dubberly, Pension Investments Manager at the BBC Pension Trusts. His comments are insightful and demonstrate the experience of someone who allocated to ILS and cat bonds just before what was one of the most, if not the most, volatile year for the market.
One point that immediately becomes clear is that as a large pension fund James Dubberly feels the ILS and cat bond market can be slightly restrictive due to its size and he feels that it is quite limited for him at the moment but hopes that this will evolve over time. This is a comment often heard from large institutional investors looking at the ILS and cat bond space and is something that can only be solved by growth of the overall size of the ILS space.
He also notes that it may not be an ideal investment for everyone. As a large pension fund the BBC feel it is a suitable investment for them but they put significant time and effort into researching the space and ensuring they were happy with the structure of their chosen managers funds. Not every pension fund will have the time, resources or experience to undertake such diligence. James notes that the BBC appreciate the diversification provided within the asset class and the risk premium which is available through an investment in ILS.
James says that he is somewhat disappointed that the cat bond market itself has never fully matured. He does think it is developing and that there is a lot of interest in the cat bond market but he would like to see more development in terms of the listed market and more transparency on pricing being made available to investors.
Overall the BBC’s experience with their ILS and cat bond investment seems to have been positive, although James does note that in 2011 it only gave them a marginal return. However that’s no surprise given what happened during the year and the various issues that affected the market. He notes that their ILS investment performed very differently to equities and other return seeking investments within their fund. He finishes with a positive comment:
This asset class can provide interesting returns and genuine diversification if you can get your head around its complexity and access it at a sensible fee level with a structure that you are comfortable with.
Representatives from two other pension plans took part in this roundtable interview. Dan Bergman, Head of Investment Research and Insurance-Linked Securities at Swedish national pension fund AP3 and Philippe Trahan Portfolio Director, Insurance-Linked Securities at the Ontario Teachers’ Pension Plan.
Dan Bergman highlighted the fact that risk aversion is a factor that needs to be watched within an ILS portfolio. He says that you often have the same buyers and to some extent the same sellers in much of the ILS market, and hence if risk aversion rises after an event it can cause ILS prices to move in tandem despite being de-correlated at the peril level.
Bergman also highlighted the overly U.S. weighted nature of the ILS market and that this can make it hard for investors to diversify as much as they’d like to, especially as the more diversified opportunities are often less easy to access. Philippe Trahan meanwhile said that he is comfortable with the amount of diversification he can achieve within U.S. perils, and says that investors should not be bothered too much by the concentration of U.S. risks as diversification opportunities do exist.
Both Bergman and Trahan say that their funds exposures to ILS are beneficial, with Bergman saying that ILS suits them well despite its illiquid nature as they are a long-term investor. Trahan adds that having the right amount of ILS exposure is actually beneficial to them and they see ILS as diversifying and effectively improving their overall portfolio construction.
Bergman suggests that a 1% plus allocation to ILS would make sense for most pension funds. That’s encouraging for the sector given the small amount of funds who currently invest and the huge amount of capital in pension funds worldwide. He says that cat bond market development has been slower than hoped for but improvements in transparency and collateral solutions do show the market maturing. Trahan added that he’d like to see the ILS market grow its overall size by expanding the supply of risks to it, outside of the typical perils.
Overall, all three representatives from major pension funds are pleased with their allocations to ILS and seem positive on the market in many ways. However the cautionary message to take away from the interview is that the market does need to grow to be able to accommodate the investors who are either on the sidelines or would like to access it in the future.
It’s well worth downloading the Clear Path Analysis report on ILS at their website to read this interview and other insights in full.