Swiss Re Insurance-Linked Fund Management

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ILS Diversified Ltd., first insurance linked fund-of-funds launches


ILS Diversified Ltd. the first fund-of-funds in the insurance linked investments market solely investing in insurance-linked securities (ILS) funds to achieve a return more in-line with the market is being launched on April 1st by ILS Advisers.

Readers will be familiar with ILS Advisers as the firm behind the Eurekahedge ILS Advisers Index, an equally weighted index of 33 constituent ILS funds which tracks their performance and provides a good benchmark for how the ILS market is performing.

Now ILS Advisers has put its effort into creating a fund-of-funds strategy for the ILS market, creating ILS Diversified Ltd., a Bermuda domiciled fund vehicle, which will invest in an actively selected set of ILS funds to achieve the best possible returns across the market.

Stefan Kräuchi, founder of ILS Advisers and the ILS Diversified Ltd. fund, told Artemis; “I am very pleased to announce that two years after the official start of the Eurekahedge ILS Advisers Index we are now launching the first ILS fund-of-funds that allows investors to achieve similar returns as the index with slightly less volatility. We manage the fund by leveraging off the know-how that we have built up over time by establishing and maintaining the Eurekahedge ILS Advisers Index.”

ILS Advisers has derived a scoring strategy, with which it has assessed and scored the majority of the ILS funds available in the market. It has then selected the top funds which it feels perform most strongly and have the lowest volatility and invests across them all.

Stefan Kräuchi commented; “The ILS Diversified Ltd. is a high quality, attractively priced ILS fund product based on our rigorous fund selection process combined with our state of the art proprietary portfolio construction approach that combines traditional portfolio optimization with risk management techniques from the reinsurance industry.”

Through this strategy ILS Diversified Ltd. aims to provide a return which broadly tracks the ILS market, but which ILS Advisers feel could actually better their ILS index due to the scoring and active selection of the underlying ILS managers.

As you can see from the chart below, a look back at how the ILS Diversified Ltd. portfolio would have performed in recent years, versus the ILS Advisers Index, shows the lower volatility and smoother returns that ILS Diversified could achieve.

Historical cumulative returns for ILS Diversified Ltd. vs the Eurekahedge ILS Advisers Index

Historical cumulative returns for ILS Diversified Ltd. vs the Eurekahedge ILS Advisers Index (Pro forma, based on active fund selection and weighting)

By actively selecting what ILS Advisers see as the best performing ILS funds in the market it hopes to be able to outperform a market tracking index and offer lower volatility to its investors. Investors in ILS Diversified Ltd. will appreciate the ability to access the return of the ILS market, without being as exposed to any single managers risk selection criteria. ILS Diversified Ltd. aims to have investments in between 8 to 10, or perhaps more, underlying ILS funds at any one time.

“At first we were a bit skeptical ourselves about a fund-of-funds approach. However given the nature of the asset class it makes a lot of sense since the performances of the different funds in the index tend to show wide dispersions in the case of risk events and therefore diversification benefits are evident. By limiting ourselves to a selection of 8 to 10 funds we avoid the risk of over-diversification, meaning the risk of diversifying away performance,” Stefan Kräuchi explained.

The strategy should provide investors with a more balanced return, more similar to a market tracking investment. This should be extremely attractive to many investors who have been looking at the ILS market benchmarks, such as the Swiss Re indices or the ILS Adviser Index itself, and wondering how they can track the market.

Those new to ILS investing may appreciate the ability to track the markets return instead of any one manager, they will also no doubt appreciate someone else performing the manager selection duties. For investors already in ILS and larger investors such as pension funds who may invest in multiple ILS strategies, the ability to make a single investment and gain exposure to the returns of a number of funds could be particularly attractive.

ILS Advisers explained some of the fund selection process it follows to Artemis. The ILS Diversified Ltd. fund-of-funds will have a focus on gaining exposure to private ILS transactions, as it feels the premiums are currently more stable than in the catastrophe bond market, so the percentage of a fund invested in private ILS will be a factor.

Other key factors in its selection of ILS funds to invest in are whether the fund is open to subscriptions, many are not due to market conditions, whether the fund has more than one year of track record and whether the fund has more than $100m of assets under management in the strategy.

That gives ILS Advisers a universe of what it terms ‘investable ILS funds’. It then follows an active selection process to choose what it feels are the best in class ILS funds, based on both qualitative and quantitative criteria. This typically results with between 8 and 10 funds selected to invest directly in.

ILS Advisers then applies portfolio optimisation techniques using specialist software and while bearing in mind concentration limits for perils it derives allocation amounts per fund and manager, while also bearing in mind concentration limits per fund of 15% and per manager of 30% of the assets of ILS Diversified Ltd.

All the results are then reviewed based on risk management factors to ensure that the mix of perils and expected losses of the fund-of-funds are maintained within pre-defined boundaries. Once happy with the risk metrics the investments are made. The ILS Diversified Ltd. portfolio will be constantly re-evaluated to ensure that it is investing in what ILS Advisers feel are the best available ILS funds and that allocations remain aligned with its targets.

The interesting thing about an ILS fund-of-funds is that the other managers in the ILS space may appreciate being included and begin to look at that as a benchmark of which are the most attractive funds in the space. Those included will be delighted with a new potential source of investment capital, while those not included may seek to improve their scoring under the ILS Diversified Ltd. rubric in order to be included.

Stefan Kräuchi said that ILS managers have reacted positively to the launch of the ILS Diversified Ltd. fund-of-funds; “Not only from potential investors but also from ILS managers our fund has received very positive feedback. We are convinced that our fund will bring new investors to the asset class who either do not have the resources to do their own analysis and due diligence on the different ILS funds or for investors who want to take a diversified approach to the asset class.”

Agreeing that the fund could become a benchmark for the most attractive ILS funds, Kräuchi said; “In addition it is a sign of quality for the managers who have made it through our rigorous fund selection process and are now represented in our ILS Diversified Ltd.”

The ILS Diversified Ltd. fund will target a return of between 6% and 8%, with an expected loss of around 3% across the portfolio. At launch the portfolio is likely to be 50% exposed to catastrophe bonds, 30% to private ILS, with the remainder in industry loss warrants (ILW’s) and cash at any one time. The percentage allocated to private ILS is likely to grow as the ILS fund market moves more into these private reinsurance contracts.

It will be interesting to see how the ILS Diversified Ltd. fund is received. At launch today ILS Diversified has approximately $21m in seed capital from core investors, but that number will likely grow quite quickly if investors like this approach.

Many investors have been looking for a fund-of-funds strategy in the insurance linked investments and insurance-linked securities space. As a result, ILS Diversified Ltd. could find itself in great demand.

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