Dorian dents August ILS fund returns, shows reserving policies vary

As expected, the mark-to-market impacts to catastrophe bond valuations right at the end of August caused by hurricane Dorian has driven the overall average return of insurance-linked securities (ILS), cat bond and collateralized reinsurance funds for August much lower.

With one ILS fund still to report, having delayed its August returns disclosure, the ILS and cat bond fund sector as tracked by the Eurekahedge ILS Advisers Index has averaged a return of just 0.09% for August 2019.

That took cumulative performance year-to-date for the ILS and cat bond fund sector to -0.63%, which is the second lowest performance since 2006, only ranking behind 2011.

August’s average ILS fund return of 0.09% is far behind the historical average for the month, which is a positive return of 0.63%.

ILS funds have generally been performing well aside from continued loss creep that has affected some collateralised reinsurance strategies, with few fresh catastrophe event impacts until hurricane Dorian came along in late August.

While Dorian has not caused any catastrophe bond losses, the fact the storm threatened Florida right around the end of the month meant that positions showed a mark-to-market valuation decline that cat bond funds then had to use to deliver their August returns, as we explained almost a month ago here.

That depressed the return of the catastrophe bond market for the month, which has in turn dragged down the performance of the Eurekahedge ILS Advisers Index.

In total, 16 of the 32 constituent ILS funds tracked by ILS Advisers were positive for the month, while the cat bond focused funds as a group were negative.

“Pure cat bond funds as a group were down by 0.07%, while the subgroup of funds whose strategies include private ILS increased by 0.22%,” ILS Advisers Founder Stefan Kräuchi explained. “Private ILS funds on average continued to underperform pure cat bond funds YTD.”

As is becoming quite common, there was a wide gap between the best and worst performing fund again and some of the private ILS funds focused on collateralised reinsurance saw high returns.

“The biggest gainer was a private ILS fund that increased by 2.26%. The difference between the best and the worst performing fund was 3.69 percentage points,” Kräuchi said.

Despite the fact some private ILS funds have begun to see very high seasonally influenced returns over the late summer months, as we explained the other day here. Over the year so far, they still lag behind cat bond returns as a group, which is largely due to the influence of loss creep earlier this year.

Kräuchi explained that, “Private ILS funds underperformed pure cat bond funds by 2.50 percentage points on an annualized basis year-to-date.”

Explaining the influence that hurricane Dorian’s approach had on cat bond funds, Kräuchi told us, “Dorian was once thought a very serious threat to Florida when it first approached Bahamas on 1st of September. The cat bond market was first to react.

“The price dropped dramatically by 0.78% for all cat bonds and 1.21% for US wind cat bonds as of the last week of August right before the landfall of Dorian. However, as Dorian missed Florida and the losses were much lower than initial estimates, prices recovered in the following weeks.”

The way ILS funds have dealt with the mark-to-market and valuation impact of hurricane Dorian is also interesting, as it shows up further differences in approaches to reserving and calculating potential loss impacts to ILS fund portfolios.

“The potential threat of Florida landfall of Dorian as of the last day of August, however, gave some interesting observations on the valuation of private contracts among funds,” Kräuchi explained.

Continuing, “While most of the private ILS funds allocated the Dorian loss to September NAV, some funds allocated the losses into August NAV. The timing of redemptions of ILS funds during the season may be the main concern, as funds do not allow investors to redeem without taking any losses from Dorian.

“Investors should be aware of such variation of loss reserving policies among managers when comparing fund results”

This is an important point, as the details on when potential or actual losses are factored into fund returns are important to fund operations and can be dictated by certain features such as gates and periodic redemptions. Important terms for end-investors to consider when making their allocation decisions.

There’s also the issue of when mark-to-market recoveries are factored back into fund NAV’s and returns, something that should result in a boost for September returns especially for the pure cat bond fund strategies.

As we explained the other day, some ILS funds (particularly on the private and collateralised reinsurance side) have started to deliver relatively high seasonally influenced returns.

September could turn out to be a much stronger month for the ILS fund market and has the potential to drive Index performance into positive territory for the year. We’ll report when the next set of Index results are in.

You can track the Eurekahedge ILS Advisers Index on Artemis here, including the USD hedged version of the index. It comprises an equally weighted index of 32 constituent insurance-linked investment 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.