In the latest monthly managers update for the DCG Iris insurance-linked securities fund, the London Stock Exchange listed closed end ILS investment fund operated by Dexion Capital, it is revealed that Credit Suisse intends to move one of its funds out of catastrophe bonds in an attempt to find a better return for investors.
Credit Suisse is effectively the investment manager for the DCG Iris ILS fund as one of the its ILS funds acts as a master fund for DCG Iris. DCG Iris is an exchange listed fund which acts as a feeder of sorts to Credit Suisse’s CS Iris Low Volatility Plus fund (the Master Fund). DCG Iris invests all of its assets in the CS Iris Low Volatility Plus fund and as a result Credit Suisse provides the insight in the monthly reports on the funds performance.
In the DCG Iris managers report for the month of April, Credit Suisse discusses conditions in the catastrophe bond issuance market. It says that increased cat bond issuance continued in April in response to strong investor demand, however they are seeing mixed pricing on primary cat bond issues.
Credit Suisse says that some new cat bond issues have been priced well below the DCG Iris expected returns target on a risk-adjusted basis. This is true, recent deals have been pricing at all-time lows, as we’ve covered in-depth, and DCG Iris has a return target of Libor +5% to 7%. Some recent cat bonds have priced offering investors a return as low as 2.5% which clearly wouldn’t help DCG Iris meet its targets.
Credit Suisse said that given the Master Fund (its own CS Iris Low Volatility Plus fund) has no requirement to hold cat bonds, it will look to move the fund strategically out of cat bonds into higher yielding instruments over the next few months, depending on market conditions. Cat bonds currently only make up a small part of the overall Iris portfolio, insurance-linked swaps make up the bulk of it.
This is interesting and perhaps shouldn’t be taken to mean that Credit Suisse will move CS Iris out of cat bonds altogether. For a low volatility fund such as this, catastrophe bonds have provided an excellent way to get the target returns required with minimum risk and volatility. Moving out into more insurance-linked swaps, reinsurance-linked contracts, industry loss warranties (ILWs) or other contracts may result in an increase in volatility if not carefully managed.
Credit Suisse is an extremely experienced investment and portfolio manager in the ILS space and we’d expect it to offload some cat bonds with low returns to start with. At the same time it might look to begin gradually deploying capital into some of the lower risk layers of reinsurance contracts it collateralizes for its other, higher volatility funds.
In the report Credit Suisse says that the June investment opportunities it sees are in Florida, Australia and New Zealand renewals. With DCG Iris having just raised an additional £9m it is possible that Credit Suisse may have put this to good use in the recent renewals.
For investors in DCG Iris there should be no discernible difference in the fund, although they may see a more consistent return across the months where seasonality would pressure cat bond prices typically. However with the ongoing changes in the cat bond and reinsurance market Credit Suisse may find this kind of low volatility fund play a little more time-consuming to manage when rates are declining across many catastrophe lines of business.
Credit Suisse said that in the run up to the mid-year renewals the Master Fund (CS Iris Low Volatility) is well positioned going into the U.S. hurricane season to meet its performance expectations.
It will be interesting to see whether there is any discernible movement in the returns of DCG Iris as this new strategy filters through. It returned 0.49% in April and had returned 2.11% for the first four months of the year. That would make you believe the fund was on target to meet its performance target of 5% to 7% over Libor, so perhaps Credit Suisse is moving quickly as it believes cat bond rates are down for the foreseeable future.
It’s a sensible move by the managers of the fund to move away from taking on new cat bond risk at rates below their targeted returns. It would make no sense to continue investing in the asset class at below target rates. As and when new cat bonds come to market with higher rates we will likely see Credit Suisse participate in them but for its other funds, not the CS Iris Low Volatility Plus.