ILS Diversified Ltd., a fund-of-funds strategy which invests in an actively selected range of insurance and reinsurance linked investments funds, has seen impressive performance in 2015 to-date, outperforming its benchmark Index and demonstrating the benefits of the strategy.
Launched in April 2014 by ILS Advisers, the firm behind the Eurekahedge ILS Advisers Index, the Bermuda domiciled fund, although ILS Advisers operates out of Hong Kong offices, a unique aspect as the only ILS manager in Asia, actively invests across a group of ILS funds, aiming to select an attractive mix to generate the best possible returns across the market.
In September 2015 the ILS Diversified strategy saw one of the underlying funds achieve a 3% return, two that returned over 2% and three ILS funds that returned more than 1%.
That shows the range of returns from the underlying ILS fund strategies, something that makes a fund-of-funds approach so attractive as it allows an ILS strategy to be broadly diversified across both perils, classes of reinsurance business and also across underwriting disciplines at ILS fund managers.
Artemis spoke with Stefan Kräuchi, founder of ILS Advisers and the portfolio manager for ILS Diversified Ltd. Kräuchi explained the background to the index or fund-of-funds approach and its application to ILS.
“We believe the starting point to create an outstanding portfolio of ILS managers is to have a good overview of the overall ILS fund offering. In this respect our joint initiative with Eurekahedge in 2012 to establish an index of ILS funds definitely created a solid base,” Kräuchi said.
The Index contains 34 constituent ILS funds, ranging from pure catastrophe bond strategies with lower returns to much higher performance private ILS and collateralised reinsurance strategies. By investing across a range of these funds, ILS Diversified can achieve a balance across the markets risk/return profile.
Kräuchi continued; “Starting from knowing the funds and managers we have created our proprietary rating system to rank the funds based on different quantitative and qualitative criteria.
“We typically start with a selection of 8 to 10 funds and then build the optimal portfolio in a process that involves a number of steps. In this optimization process we take into account among other factors instrument, peril allocation and expected loss.”
The key to achieving a balance of performance and volatility is in having hard and fast rules that define the amount of exposure to specific risks, as well as restrictions on how much exposure to a single manager or underwriting strategy the ILS Diversified fund has.
When investing in multiple ILS funds it is important to consider exposure accumulation risk, as well as the risk of putting too much reliance on a single underwriting team. The aim is to access the best of the ILS market, both in terms of risk/return, as well as in expertise.
“We have set hard quantitative constraints such as allocation per single peril and expected loss and allocation per single manager. Our portfolio typically holds less than 10 different funds and we set the constraint for maximum exposure to a single manager to be 30% of our NAV,” continued Kräuchi.
Where the ILS Diversified strategy really comes into its own is in its ability to outperform the Index of the market.
Kräuchi explained how his strategy has been doing since its launch; “Since its inception in April 2014 the fund has been able to outperform its benchmark, the Eurekahedge ILS Advisers Index by 2.12% net of fees.”
That’s impressive enough, but perhaps more impressive is the fact that in the first nine months of 2015, to the end of September, ILS Diversified has outperformed the Eurekahedge ILS Advisers Index by 1.48%, having gained 4.95% net of fees in its USD class.
Being diversified across the market, through investments in up to 10 underlying ILS fund strategies, allows ILS Diversified to benefit from seasonal effects, such as the recent bounce back in catastrophe bond prices, but then to shift to other funds with less cat bond focus when more suited as well.
The flexibility this provides is greater than would be found in a single ILS fund strategy perhaps, which could be very attractive for institutional investors looking to extract the best performance possible from the ILS and reinsurance market, while not being tied to one single strategy.
Kräuchi said that it is this active selection that delivers the benchmark beating performance for ILS Diversified; “Our performance allocation shows that about 70% of the outperformance stems from the manager selection and about 30% comes from the instrument selection, meaning the weighting of cat bonds, private ILS and ILW’s.”
As of the end of September 2015 the ILS Diversified portfolio was around 10% allocated to pure catastrophe bond funds and 87% to ILS funds that also invest in private transactions and collateralised reinsurance.