The average return of insurance-linked securities (ILS) funds in December was just 0.07%, as the severe weather events in the month and year hit private ILS and collateralised reinsurance deals. Meanwhile the full-year 2015 average ILS fund return managed just 4.22%.
The Eurekahedge ILS Advisers Index reports its third lowest annual return in a decade for 2015, coming in at an average return of 4.22% across the group of 31 constituent ILS funds that the Index tracks. Only 2011, when the Index returned -0.14% and 2008 which saw an annual return of 3.83% are lower. 2014 saw an average return of 5.42%.
The impact of the softened reinsurance market on ILS rates and catastrophe bond returns is clear among the Index constituents. Also the difference between strategies in the ILS fund market is demonstrated by the gulf between different fund returns.
Stefan Kräuchi, founder of ILS Advisers, explained the annual performance of the Index; “In 2015, pure cat bond funds as a group were up by 1.93% while the subgroup of funds whose strategies include private ILS increased by 5.40%.”
The gap between best and worst performing ILS fund in 2015, among the 31 tracked by the Index, is a huge 11.64%.
“The best performer made 12.36%, a private ILS fund, while the worst performer is a pure cat bond fund who delivered 0.72% return. The difference can be well explained by the natures among asset classes as well as strategies implemented by fund managers,” Kräuchi continued.
However, despite the much lower returns evident among the Index constituents, the metrics that investors commonly use to assess and asset class remain compelling.
Kräuchi continued; “On the yearly basis, in absence of major events, we see a quite stable performance in 2015 in the ILS space. Over the past year, competition remained strong and AUM increased significantly for ILS fund industry. The yearly performance was on the lower band compared to historical figures, mainly due to soft market conditions. However, the risk profile still remains attractive, with annualized volatility of 2.07%, Sharpe ratio of 2.16x and Sortino ratio of 3.18x.”
It’s also evident by the gulf between best and worst performing funds that attractive returns are certainly possible in ILS funds, but the selection of manager and strategy is perhaps increasing in importance now that the market is so soft.
But the factors that make the asset class a compelling one remain, the low correlation with financial markets and steady, relatively stable returns over a longer-term horizon continue to be a major selling point for ILS fund managers services.
That’s not to say ILS funds don’t suffer losses and December demonstrated exactly that, with a number of catastrophe and weather events seen potentially hitting some private ILS fund contracts and causing a need for reserving.
December performance showed the different strategies of cat bond only or funds that also invest in private ILS behaving very differently, as events and the impact of full-year aggregate contracts hit the subgroup of ILS funds investing in private contracts and collateralised reinsurance deals.
“20 funds represented in the Eurekahedge ILS Advisers Index made positive returns,” Kräuchi explained. “Among the 11 negative funds, 5 are pure cat bond funds.”
“With the lowest single fund return -1.65% and the highest one 0.87%, the monthly performance difference increased to 2.52%. Pure cat bond funds as a group were up by 0.13% while the subgroup of funds whose strategies include private ILS increased by 0.03%,” he continued.
The gap between private ILS funds and pure catastrophe bond funds average performance for the year was 3.47%, with pure cat bond funds up by 1.93% while the subgroup of funds whose strategies include private ILS rose by 5.40%.
Being the last month of the year some annual aggregate private ILS contracts neared their limits, resulting in some ILS funds setting up side pockets for any contracts they were uncertain whether would face losses. This hit the performance of the private ILS subgroup.
Kräuchi said; “December was an important month for private ILS funds to evaluate the total yearly losses of the aggregate covers since it’s more likely these contracts to be hit nearing expiration due to losses accumulated over the year, which also dragged down performance of some private ILS funds.”
Additionally some of the weather events in December resulted in further impacts to some of the private ILS funds.
“UK floods and storms, Australian bushfire and cyclones and U.S. severe weather jointly affected the December performance of some private ILS funds,” explained Kräuchi.
Catastrophe bond funds in December were impacted by prices falling, likely a result of the end of year renewal season causing managers to adjust portfolios, as well as inflows changing demand patterns and the continued shift towards collateralised reinsurance.
So a difficult month to finish the year on, particularly for the ILS funds investing in private deals and collateralised reinsurance. 2015 has provided a good example of how the ILS fund market is increasingly exposed to the kind of attritional weather or catastrophe events that have negatively affected some of the funds this year.
As ILS funds increasingly look to collateralised reinsurance they are increasingly having to pay claims, or reserve for potential claims and set up sidepockets. This requires another discipline and skill set and signals an ongoing maturation of the ILS fund market, as fund managers are increasingly seen as efficient reinsurance companies rather than purely asset managers.
With new sidepockets being set up in December by some ILS funds there will be a number of months before those can be reconciled and releases made, where possible. This could boost some funds returns in months to come and it is encouraging to see prudent reserving happening in the ILS fund space.
With pricing of catastrophe risks seemingly near a floor and stabilising it will be interesting to watch 2016 and to see how the ILS fund market performs.
Kräuchi said that most of the ILS funds reporting to ILS Advisers are now set up for 2016; “Most funds have now finished the January renewal 2016. According to funds that reported to us, the renewal result is quite in line with our prediction previously, especially the slight rate reduction for U.S. perils. We are also happy to see there is no significant loosening of terms and conditions compared to last renewal.”
2016 promises to be an interest year as the private ILS funds look to manage their perhaps broadening exposures and the catastrophe bond fund managers look to manage portfolios to attempt to maximise returns in a soft market.
You can track the Eurekahedge ILS Advisers Index on Artemis here, including the new USD hedged version of the index. It comprises an equally weighted index of 32 constituent ILS funds which tracks their performance and is the first benchmark that allows a comparison between different insurance-linked securities fund managers in the ILS, reinsurance-linked and catastrophe bond investment space.