The Covid-19 coronavirus pandemic is having an evident effect on the catastrophe bond market, seen largely in the secondary market but with expected future ramifications for primary cat bond issuance market conditions as well, according to executives at Schroder-Secquaero.
At the same time, the private ILS market is currently outperforming as, being a less liquid ILS asset, they are largely immune to the effects of secondary supply, demand and trading that are how stress manifests in the cat bond market, making the more private side of ILS the more stable right now.
Speaking with Artemis, Stephan Ruoff the Deputy Head of specialist ILS asset manager Schroder Secquaero and Daniel Ineichen the Head of ILS Fund Management at the firm, explained how they are feeling the influence of the coronavirus outbreak in their day-to-day business.
Ruoff told us, “The outbreak of the COVID-19 virus has led to significant corrections in the stock, commodity and bond markets. The ILS asset class in general and the Schroder Secquaero strategies in particular have held up very well in this environment.
“The advantages of an uncorrelated asset class such as ILS become apparent again.”
Across the ILS market the effects of the coronavirus pandemic are felt differently though, with the liquidity of catastrophe bonds meaning that has been the first area to experience an impact.
“We see effects on both primary and secondary markets,” Ineichen explained, saying on the primary cat bond market that, “In the first two months of the year, there was sufficient capacity and deals were – in parts substantially – upsized and/or priced at the lower end of the range.
“In March, the momentum shifted. Deals were harder to place and priced towards or at the higher end of the initial price range with, if so, marginally improved sizes. One deal was pulled from the market, as it did not get enough investor support at the offered terms. There are currently a few transactions in the primary market and it will be interesting to see how well they will be received by investors.”
Ineichen said, “Following the corrections in the financial markets, the market saw some larger redemptions, mainly from multi-asset strategies trying to generate liquidity. This has resulted in a slight oversupply of paper and led to some price reductions. The increased secondary market activity so far has been absorbed fairly well but we could see more activity if the volatility prevails.”
The Schroder Secquaero team believe that this dynamic may present a buying opportunity, something the investment manager may be well-positioned to capitalise on given its platform includes UCITS funds where inflows may be easier to source more quickly.
“Reduced price levels might provide attractive entry levels for ILS managers such as Schroder Secquaero,” Ruoff said. “Due to their floating rate nature and their short maturities, bonds will bounce back quickly once the situation has calmed. We have observed similar dynamics in the past during the global financial market crisis in 2008 as well as other corrections.”
On the other side of the ILS market, where collateralised reinsurance and retrocession transactions are largely negotiated in the course of the renewal cycle and entered into privately, the coronavirus related volatility and uncertainty has not had as much of an effect, it seems.
Ruoff explained to us, “Private transactions, due to their buy and hold nature and less-frequent dealing cycles, have seen hardly any impairment and are performing very much in line with expectations. Currently, it is this market segment that is outperforming.
“All our portfolios are up year-to-date and have seen strong February performances. We also expect positive performance for the private transaction-heavy portfolios in the month of March.”
On performance for the more catastrophe bond focused investment portfolios, Ineichen commented, “The cat bond market has performed well in the first two months of the year. The performance in March will mainly be driven by mark-to-markets. While performance was flat in the first couple of weeks, we expect to slip into slightly negative due to increased selling pressure.”
The ILS market continues to demonstrate its robustness as a relatively uncorrelated alternative asset class with prices holding up well in the face of broader financial market pressures.
Ruoff explained that this does mean that the ILS market can become a source of cash as a result, but he also sees the long-term prospects as positive even if requests for redemptions did rise.
“Investors have seen severe drawdowns across the board and ILS was one of the very few asset classes that performed well and provided the well-needed diversification. We only have observed limited redemption activities and selling pressure came mainly from market participants combining ILS with other exposures,” he explained.
Adding that, “So far, the market has held up pretty well and only experienced a small drawdown in March, staying positive for the year. If the volatility in the overall markets remain elevated for some time, it could be that the ILS market will also have to deal with more volatility or be used as source of liquidity, hence facing some redemptions.”
While the opportunity that could present may mean that specialist ILS fund managers, such as Schroder Secquaero, are well positioned.
“This would provide attractive entry levels,” Ruoff said.
Further explained, “Keep in mind that the risks in the ILS market are very independent from the economic cycle. Hence, in times of crisis like this where credit markets could face larger amounts of defaults, we have historically seen rather inflows than outflows as ILS provide an attractive hedge during such times.
“This is a time where we have to deal with extraordinary circumstances and keep a very close eye on the overall markets and the ILS segment specifically. Natural Catastrophe-driven instruments are largely uncorrelated to geopolitical and financial market tensions and provide investors with stability in their portfolio during these unprecedented times.
“Schroder Secquaero ILS solutions are well-positioned in the current setting and we observe that, as mentioned, the underlying fundamentals remain in good shape.”