Education, liquidity, more perils to drive retail investor interest in ILS: SIFMA

Greater education around the insurance-linked securities (ILS) asset class, coupled with the development of a secondary market and the expansion into new perils, will help make ILS fund participation more attractive for sophisticated retail investors, according to industry experts.

While institutional investors such as pension funds are a dominant force in the ILS fund space, retail, or individual investors do participate in the sector albeit to a lesser extent.

These are largely the more sophisticated, high-net-worth retail end of the spectrum, not your average individual investor.

However, according to panellists on day two of the recently held SIFMA IRLS 2021 conference, the ILS sector has an opportunity to adapt and evolve in a way that heightens its attractiveness as an alternative asset class, ultimately opening itself up to a broader set of investors.

“I think what we knew going in but learned, particularly because in the first few years of a product being available, and unfortunately but is often the case, you get bad years early. And, so, you really have to be able to communicate frequently; explaining the risks, what’s going on, what’s happening now to premiums. When you have losses, how does that impact future expected returns,” said Larry Swedroe, Chief Research Officer, Buckingham Wealth Partners.

“It really takes a good advisor walking their clients through the risks here and what can happen. ILS is going to have sometimes two, three bad years in a row, like 2004 and 2005, and then the next 11 years there was every single year was a great year. And, of course, the best returns came in 06, 07, 08, when the premiums were great and then money flows in and then the premium goes down and eventually you’ll get a bad year.

“And you have to be willing to live through those cycles and not try to time that, because it won’t work and it really takes a lot of client education,” he added.

Liquidity was also noted by the panel as something that would drive greater interest from retail investors into the ILS fund space, whether in the interval, mutual, or the UCITS fund arena.

According to Chin Liu, Managing Director, Portfolio Manager, Director of Insurance-Linked Securities, and Director of Fixed Income Solutions, and Responsible Investment Research, Amundi US, another way to address liquidity is via the structure of the instruments.

“So, for example, if we could structure instruments with an even shorter tail, like more parametric driven transactions, more index driven transactions that probably would help, compared with pure indemnity transactions.

“I think part of the challenges with all the trapping is because of the loss uncertainties. So, if we can improve that,” said Liu.

Additionally, Liu feels that broadening the reach of ILS structures and capacity to more perils would also help facilitate greater interest and growth.

“I do believe that over long-term cyber could potentially play an important role in the universe. But the challenge or the question is, how do we get comfortable with the modelling, with the history. How do we make sure investors are fairly compensated for the risk they’re taking. But that’s another area with significant growth potential,” he said.

Daniel Ineichen, Head of ILS Fund Management at Schroder Secquaero, noted both the complexity of the asset class and the lack of capacity on the tradeable side; suggesting that ultimately, transparency could be improved.

“So, the communication aspect is important towards the investors. But when I look at the entire value chain, what we also need to get is actually, from my perspective, a decent amount of capacity in tradable format. And, also, kind of a beta play ultimately against which people can measure the industry return. We have seen attempts in the past and it’s not easy because of the way the losses develop,” said Ineichen.

He also explained how it would be nice to see more repeat issuers in the marketplace, those that participate in the good and the bad years and are perhaps less opportunistic.

“That will help broaden the market, that will help creating transparency, and it will help ultimately make the market more accessible for many investors,” said Ineichen.

Echoing previous comments made by Swedroe, Ineichen also commented on the development of a secondary market. Brokers, he feels, could help to facilitate this because “it solves problems of side pockets, it solves problems of adverse loss development that we have.”

The panel also featured Brian Kelliher, Partner, Asset Management and Investment Funds, Dillion Eustace, who reiterated earlier comments on the need for education.

“In Europe, for example, any financial advisor, or for that matter a discretionary portfolio manager, has a duty to ensure that these products are suitable for investors. And even when an investor executes with an execution firm, they have a duty to ensure, particularly with our complex products, to ensure that they’re appropriate.

“So, that educational piece is really important, I think, at the advisory level in order to make investors aware of the non-correlated or low correlation of those products, and how different they are to traditional type-products,” said Kelliher.