As the level of uncertainty surrounding the insurance industry loss from hurricane Sandy reduces, investment managers with exposure to the storm are beginning to resolve the situation around side-pocket investments. As we wrote at the start of February, the DCG Iris ILS fund is making progress on merging C Shares back into its Ordinary share class. Now, the Master Fund manager to DCG Iris, Credit Suisse, has announced that it is releasing some side-pocket investments.
Credit Suisse is the investment manager of the CS Iris Low Volatility Plus fund, which invests in ILS, catastrophe bonds and reinsurance-linked contracts and is the Master Fund to DCG Iris. After Sandy struck, Credit Suisse updated that it had a number of investments in the fund which it now considered illiquid due to exposure to losses from hurricane Sandy.
Because of the illiquid nature of the investments Credit Suisse established side-pockets into which these investments could be put to segregate them from other investments which had no exposure to Sandy. This helped Credit Suisse ensure that any future changes in value on the investments exposed to Sandy would only impact investors who had committed to the fund at the time of the event and so any new capital inflows would not be exposed.
Now that loss reporting agency PCS has given its second update on the estimated industry losses from Sandy, which it announced as $18.75 billion, Credit Suisse has found that a number of the side-pocketed investments are unlikely to face any losses. Credit Suisse believes that the industry loss estimate is likely to increase at the next reporting interval, in mid to late March, but says that the reserving actuary appointed to the fund has put an upper bound to the loss estimates of $22.5 billion.
Wit that upper bound in mind, Credit Suisse says that the illiquid, side-pocketed investments have been re-examined and it now believes that eight of the twelve no longer have valuation uncertainty or are illiquid. For these eight, Credit Suisse now believes that they have no exposure to losses from hurricane Sandy and that the trigger for the instruments is unlikely to be reached. That suggests that these eight investments have an industry loss trigger of either $25 billion or $30 billion, which Credit Suisse now believes is above where the next PCS update will be set.
Credit Suisse said that it has received confirmation from the counterparties on the eight investments that they will not be subject to any impact from Sandy. As a result, the eight out of the twelve illiquid investments will be released from the side-pocket using a valuation from the NAV at 31st January, which corresponds to 80% of the Sandy side-pocket. The Sandy ‘S Shares’ from the side-pocket will be redeemed and new participating shares of the same value will be given to shareholders.
The four remaining side-pocketed investments will now await the next industry loss estimate and Credit Suisse said that it will reassess them at that time, it expects to be able to evaluate whether these four investments can also be released within the next couple of months.
The upshot of this is that ILS fund managers are operating very prudent strategies for dealing with potential exposures, which will be appreciated by their investors. Of course there is still scope for the loss estimate to creep above the upper bound that Credit Suisse has set for itself, but we will have to wait till later in March to find out whether that happens.