Swiss Re Insurance-Linked Fund Management

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Cat bond & ILS fund returns demolish benchmarks in 2022


Once again, the insurance-linked securities (ILS) market is demonstrating the value of making investments into relatively uncorrelated assets, as some catastrophe bond and ILS fund strategies have been delivering benchmark-beating returns for the first few months of 2022, against the grain of many other asset classes.

up-chartThe fact cat bonds and ILS, so returns derived directly from the risk side of insurance and reinsurance contracts, are in the main structurally uncorrelated to the wider capital markets has again been on display during a period of heightened volatility for financial markets and many asset classes.

The general lack of correlation remains one of the biggest selling-points for the ILS asset class and this has been the case since its inception.

When broader global events drive volatility through many asset classes, ILS assets and their major components of catastrophe bonds, collateralised reinsurance and other insurance-linked investments, have continued to deliver positive performance.

In fact, we’re aware that a decent number of ILS fund strategies have been demolishing their benchmarks for the first-quarter of 2022 and beyond.

In some cases, ILS fund strategies have beaten benchmark references significantly, as the market volatility that has emerged, largely due to Russia’s invasion of Ukraine, global inflationary fears and rate rises, have caused many other investment classes to suffer large declines.

For example, we’re aware of ILS strategies returning anything from 0.3% to over 3% for Q1 of 2022, while some high-yield and corporate bond benchmarks were down -5%. Some down much more than that.

At the same time, US Treasury benchmarks are barely breaking even and equities are in some sectors tanking (growth equity and tech), others remaining very depressed. We won’t even mention the cryptocurrency bloodbath of recent days.

In a particularly volatile financial environment, diversifying sources of return that outperform can be looked on very favourably.

Investors are often drawn to alternative investment classes to avoid this volatility in broader financial markets.

Of course, any investor allocating to ILS should still be made aware that there is volatility inherent in the core catastrophe related risk assets that are underwritten and invested in. But that volatility is generally not going to be affected by broader macro trends and rarely moves in precisely the same direction as financial benchmarks.

Looking at some of the components of ILS, we’ve seen cat bond funds having a slightly depressed first-quarter, with price pressure affecting the returns of some strategies in the space and the Swiss Re cat bond index only returning 0.48% for Q1 2022.

Some of the lower-risk cat bonds funds saw lower returns than that for Q1, as a result of the price pressure the market has been under.

However, this was still outperformance and for major institutional investors, any asset class that delivered a slightly positive return was looked on favourably through the start of 2022.

Some of the higher-risk catastrophe bond fund strategies delivered very good performance, with returns of more than 1% on offer through the first four months of the year.

Again, this against the backdrop of global macro financial markets volatility, is a very attractive diversifying asset class.

At the same time, ILS funds invested across the broader spectrum of private collateralised reinsurance, retrocession and quota share sidecar type deals, seem to have had a generally quite good start to the year, despite some catastrophe activity in Australia, Europe and the United States.

We saw returns of 1% to 2% for the first-quarter among private ILS fund strategies, sometimes higher, for higher risk funds, and these were seen quite widely across the space.

Of course there are always higher returns to be had by taking on more risk, but with the first-quarter generally a more benign one, these strategies have had a chance to start the year with benchmark beating returns as well.

Beating benchmarks is one thing and when global geopolitics and macro factors drive fear into financial markets you’d expect the ILS market’s return to benefit by looking particularly attractive at that time.

We are seeing an uptick in inbound contacts from investors asking questions about the ILS asset class in recent weeks, something we anticipate will continue as the broader capital markets remain so volatile and uncertain.

Of course, it’s always hard to benchmark ILS investments, especially on the private and collateralised reinsurance side of the market, while cat bonds can be more readily compared to fixed income securities.

Which is why most ILS fund managers provide a number of benchmarks, to give allocators something to compare against.

But right now, catastrophe bonds and ILS are delivering positive returns, even in an environment where first-quarter catastrophes remained above-average and there have been other pressures on the market, in terms of supply and demand with their inevitable effect on cat bond spreads.

As those effects tail off, catastrophe bond funds stand to benefit from much higher returning investments made through recent months, due to the price increases seen across the market.

Those higher returns are also available through hardening reinsurance rates in private ILS funds as well.

While, at the same time, terms and conditions are perhaps at their most positive, from the investor side, for quite a few years.

All of which makes cat bonds and ILS particularly attractive, as a benchmark-beating diversifier right now. Which should gain attention in institutional investor circles and ultimately lead to fresh inflows over time.

With the ILS asset class also continuing to broaden, with increasing opportunities outside of pure catastrophe risks as well. The range of options for investors to tap into insurance and reinsurance linked returns is expanding, all against a backdrop where the macro environment is making any true-diversifiers look particularly attractive.

Of course, it can be easy to demolish benchmarks when things are so volatile, but this does help to underscore the diversification argument for any alternative asset class, with insurance-linked securities (ILS) no different here.

It’s also important to add that not everyone has been positive, there are still losses being experienced, from recent catastrophe activity and creep from the prior year as event losses continue to develop.

But even ILS funds that fell to negative returns are still outperforming benchmarks in a lot of cases and at least these losses are coming from the core risk the asset class assumes (in the majority of cases), rather than being related to macro volatility.

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