Higher short-term rates boost ILS returns, reshape hedge fund attribution: Agecroft’s Steinbrugge

Higher short-term interest rates are providing an additional source of return for ILS, while also reshaping strategy-level return attribution across the hedge fund industry. As macroeconomic dynamics shift which management styles deliver relative performance, Don Steinbrugge, of Agecroft Partners, emphasises that the underlying source of an investment’s return now matters just as much as its headline figures.

In a recent article, Steinbrugge Founder and CEO of Agecroft Partners highlights how within this shifting environment, strategies that hold substantial cash or collateral, such as quantitative funds, low-net relative-value, and insurance-linked securities are benefiting from an additional source of return on their short-term holdings, whereas highly leveraged strategies face mounting pressure from elevated financing costs.

“The investment environment has changed dramatically over the past several years. After more than a decade of near zero short term interest rates, investors can once again earn a meaningful return on cash and short-term Treasury securities. As of September 2026, the Federal Reserve’s target range for the federal funds rate is 3.75% to 4.00% with more rate increases expected. Inflation has declined significantly from its 2022 peak but remains above the Federal Reserve’s 2% target,” Steinbrugge explains.

The CEO affirms that the return of meaningful short term interest rates has important implications for hedge funds.

Steinbrugge notes that while investors tend to associate rising rates with declining asset values, the impact on hedge fund strategies is more nuanced, particularly as some strategies can benefit from higher short-term rates, while others may encounter higher financing costs that can materially reduce returns.

“This distinction is particularly important for institutional investors. When evaluating hedge funds, institutions consider not only historical performance, volatility and correlation, but also the underlying sources of return. A strategy that generated attractive returns during the zero interest- rate era may have a very different expected return profile when cash earns approximately 4% and the cost of leverage has increased substantially,” Steinbrugge continued.

In addition, Steinbrugge underscores that quantitative hedge funds may also benefit from the return of meaningful short-term interest rates.

The majority of these managers use systematic models and algorithms to identify investment opportunities across equities, futures, currencies, commodities and other markets. As well as this, many quantitative strategies obtain substantial market exposure through derivatives while maintaining a considerable portion of their capital in cash or short-term fixed-income instruments.

The CEO also explained that quantitative managers may benefit from increased dispersion and volatility across financial markets. Depending on the strategy, Steinbrugge noted that managers can exploit momentum, mean reversion, statistical relationships, market microstructure and other systematic signals.

“There are, however, significant differences among quantitative strategies. Holding periods, leverage, liquidity, market exposures and the underlying models can vary considerably. Institutional investors should therefore look beyond historical returns and correlations and understand the composition of those returns. In particular, investors should distinguish between returns generated by the underlying investment strategy and returns generated by cash and collateral. As short-term rates rise, that distinction becomes increasingly important when assessing a manager’s true alpha-generating ability,” Steinbrugge said.

The CEO also flagged how the global reinsurance market and insurance-linked securities (ILS) represent a key area where higher short-term rates can be beneficial for institutional investors.

“Reinsurance strategies assume some of the liabilities of insurance companies, particularly risks associated with property damage from natural catastrophes such as hurricanes, earthquakes and wildfires. One of the primary attractions of the asset class is its relatively low correlation with traditional financial markets. Returns are driven primarily by underwriting results and insured events rather than by the direction of equity and bond markets,” Steinbrugge said.

He continued: “Higher interest rates can provide an additional source of return. Collateralized reinsurance and insurance linked securities require capital to be held against potential claims until the underlying contracts expire.”

The CEO highlighted that a considerable amount of this collateral is typically allocated to short-term securities. As short-term interest rates rise, the income produced by such collateral correspondingly increases, which ultimately creates a distinctive return structure.

As a result, this provides institutional investors with an opportunity to generate returns from both the underwriting spread and the yield derived from the collateral that supports the risk.

After a period that saw particularly strong pricing, competition has increased across the reinsurance market, which has led pricing to soften across major lines of business.

“Nevertheless, the fundamental diversification characteristics of the asset class remain relevant for investors seeking sources of return that are less dependent on traditional financial market and uncorrelated with Private Credit,” Steinbrugge added.

Further into the article, Steinbrugge stresses that short-term rates have become an important consideration for investors, noting that the broader implication for institutional investors is that the source of a hedge fund’s return matters as much as the headline return itself.

“Higher short-term rates do not benefit every hedge fund strategy equally. Strategies that maintain substantial cash or collateral may receive an additional source of return that was largely unavailable during the zero-interest-rate era. Conversely, strategies that depend heavily on leverage may see a significant portion of their returns absorbed by higher financing costs. This can materially change the relative economics of different strategies even if their underlying alpha remains unchanged,” the CEO explains.

In addition, strategies such as quantitative funds, reinsurance, and low-net or relative-value funds are expected to become more attractive to investors because they can potentially capture additional income from cash and collateral while continuing to pursue their underlying investment strategies.

Conversely, Steinbrugge indicates that highly leveraged strategies will likely see less demand as higher borrowing costs consume a larger portion of gross returns.

Nevertheless, once longer-term interest rates stabilize, fixed income-oriented hedge fund strategies may also become increasingly attractive towards investors.

All of which leads Steinbrugge to state that higher absolute yields can create a larger opportunity set in credit, rates, structured products and other fixed income markets, while also highlighting that greater dispersion among securities can create further opportunities for managers focused on relative value and security selection.

“After more than a decade in which cash generated little or no return, the economics of cash and leverage have fundamentally changed. For hedge fund investors, short-term interest rates are no longer simply a macroeconomic variable. They have become an important component of strategy level return attribution. Managers with substantial cash and collateral may now benefit from an additional source of return, while highly leveraged managers face higher financing costs that can materially reduce net performance. At the same time, higher rates can contribute to greater dispersion and create new opportunities for relative-value and quantitative strategies,” Steinbrugge said.

Concluding: “For institutional investors, the implication is straightforward: evaluating a hedge fund based solely on its historical net return is no longer sufficient. Investors should understand where that return came from, how much was generated by alpha versus cash and collateral, how much leverage was required, and how sensitive the strategy is to financing costs.”