In July insurance-linked securities (ILS) fund returns were depressed by spread tightening across much of the outstanding catastrophe bond market. The result was the lowest average return of ILS funds for the month of July since the Eurekahedge ILS Advisers Index began recording ILS fund performance.
The Eurekahedge ILS Advisers Index is an equally weighted index which tracks the performance of 30 constituent ILS funds, providing a broad measure of the performance of underlying hedge fund managers who exclusively allocate to insurance linked investments. July is typically a reasonably strong month for ILS fund performance, but in 2013 the influence of higher demand on the secondary cat bond market, combined with strong capital inflows and issuance creating a need for portfolio rebalancing, has changed the trend somewhat.
The ILS Advisers Index recorded the average return of its constituent ILS funds in July as 0.39%, a positive month but much lower than any other month of July since the inception of the index in 2006. The index is up for the year to date, with the average performance of the ILS funds it tracks reported as 3.78% for the first seven months.
Stefan Kräuchi, founder of ILS Advisers, explained; “July was positive for the Eurekahedge ILS Advisers index. However it was the worst performance for the month of July since the inception of the index. The main reason was a rather weak performance in the cat bond market due to spread widening almost across the board, with the exception of US hurricane and Japanese Typhoon bonds.”
The catastrophe bond market, as measured by Swiss Re’s indices, was down by 0.11% in July in terms of price returns and up by 0.65% in terms of total returns.
Only 1 of the 30 constituent ILS funds failed to report positive performance in July, which is a good bounce back after June saw a number of funds negatively impacted by losses from the European flooding. The negative fund is likely either accounting for flood losses later than the others or a cat bond focused fund which saw most of its portfolio widen its spreads.
ILS funds which only invest in catastrophe bonds (so pure cat bond funds) only rose by 0.29%, so seeing slightly lower performance than the ILS Advisers Index as a whole and reflecting the weak performance of the cat bond market in July.
However, ILS funds which include private transactions, so private ILS or collateralized reinsurance contracts, saw much stronger performance and averaged up 0.46% for July.
Kräuchi commented; “Funds investing with a focus on private transactions did better than pure cat bond funds and the overall index (Eurekahedge ILS Advisers Index) in July. This seems to support the thesis that better value can be found in the private segment of the market which was less impacted by strong capital inflows into the asset class.”
This interesting result for ILS funds which participate in private transactions and collateralized reinsurance contracts perhaps shows the benefits of a diversified portfolio of reinsurance-linked investments, over a pure cat bond investment strategy. The private transaction focused investment managers appear to have been less affected by the huge interest that the ILS market has seen from investors in 2013 to date.
Of course, you only have to look back a month to June, when some ILS funds were hit by private transaction exposure to the European floods, to see that while investing in private ILS transactions, or a diversified ILS fund across cat bonds and private deals, can offer good value it can also leave you exposed in areas that a cat bond strategy would not.
This highlights the importance of careful selection of an ILS manager and a fund strategy to invest in. Catastrophe bonds offer greater liquidity, a securitized product and can perhaps be easier for investors to understand, while ILS funds participating in private ILS transactions can offer greater diversity, higher returns and more scope to expand. The lesson here is to choose a reputable manager and to assess their strategy carefully.
August should see a much stronger performance from the ILS Advisers Index as the secondary cat bond market has seen rapid tightening of spreads on U.S. wind exposed cat bonds which has lifted the performance of the market considerably. As we reported yesterday, in the last month the total return of the outstanding cat bond market has measured close to 1.4% and this tightening trend looks set to continue.
This trend in the secondary catastrophe bond market should help the pure cat bond funds to a very strong month in August, perhaps stronger than their counterparts which also invest in private deals. We will update you in about one month on ILS funds performance in August.
You can see the performance of the index to date below:
You can track the Eurekahedge ILS Advisers Index on Artemis here. It comprises an equally weighted index of 30 constituent ILS 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.