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Cat bonds & ILS demonstrate lack of correlation during crisis again


The catastrophe bond and insurance-linked securities (ILS) investment market has robustly demonstrated some of its key traits through February 2022, with the general lack of correlation and largely inflation-proof returns both evident during a time of significant capital market and equity market stress.

Divergent ILS fund returnsWith the effects of a global sell-off in certain areas of the equity market, broadly declining equity valuations, rising inflationary pressure, on top of interest rate fears, plus the ongoing crisis in Ukraine after Russia invaded the country, investors around the world have had a lot to deal with in February 2022.

Reports suggest some pension funds are down double-digits for the month of February and the decline has continued, in some cases accelerating, through March thanks to the crisis in Ukraine.

Major institutional investors have not had many options to turn to over the last month to six weeks thanks to the equity market declines, while inflationary pressures and fears of rate increases also continue to rise.

Safe havens are scarce when such world-changing events as a major war in Europe occur.

But insurance-linked securities (ILS), catastrophe bonds and other direct reinsurance-linked investments, as an asset class, have delivered stable returns through this crisis, providing further evidence for the asset classes ability to deliver a source of return when all else is heading south.

We’ve seen this time and again, during periods of global financial and capital market stress, from the 2008 global financial crisis, to periods of market sell-off, to quantitative easing, credit crises, and even the COVID-19 pandemic.

During each of these periods of market stress, the ILS asset class has continued to deliver returns to those invested in it and has proved itself to remain relatively uncorrelated to the majority of these types of events.

Now, we’re in a period where geopolitical tensions are significantly heightened, while inflationary fears are escalating and the interest rate environment is very uncertain.

But still, ILS funds have been largely positive in February, aside from those impacted by natural catastrophe exposure or prior period loss creep, we understand.

In fact, we’ve heard of ILS funds with collateralized reinsurance and private ILS exposure that have delivered anything from 0.3% to 1%+ returns for the month of February, depending on levels of risk involved of course.

The catastrophe bond market had a relatively muted month, we understand, but still positive performance was seen across much of the marketplace, with returns ranging from just under 0.1% to 0.4% for the cat bonds funds we’ve seen results from so far.

The diverse nature of the returns of ILS funds and catastrophe bonds remain a key draw for many investors, although in recent years there are also increasing numbers of sophisticated investors who appreciate a broader return profile from the ILS asset class and are willing to gain more exposure to correlated risks as well (which are seen as diversifying to natural catastrophes too).

But the core motive for allocating to ILS remains its lack of correlation to broader economic, capital and financial market trends and the recent period of turbulence around the world sees ILS demonstrating this once again.

As the ILS asset class delivers both its risks and returns from sources that are structurally unlike most other asset classes, the diversification effect can be at its greatest when macro or global factors cause all else to move in tandem, typically down.

With the tragic events in Ukraine continuing to unfold, the pressure on Russia continuing to rise, the price of commodities such as oil remaining volatile, stocks still depressed, inflation risks rising, COVID-19 not yet over and still threatening to deliver nasty shocks in countries like China, while interest rates may continue to rise, right now the ILS asset class looks a relatively safe haven, from the effects of global macro events.

Relative value of ILS investments also remains high at this time, with spreads looking very attractive compared to comparable fixed income classes.

With interest rates likely to continue to move, this may persist, while the correlation benefits will likely remain evident, at least to a degree, as long as the world remains in geopolitical turmoil.

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