The investor landscape within the insurance-linked securities and catastrophe bond market has changed over the relatively short period that the market has been in operation. These days it’s the dedicated ILS and cat bond specialist investment managers and their funds which dominate the space, accounting for almost 60% of investor capacity now, compared to as little as 5% back in the markets early years.
It may seem slightly strange to some readers, but reinsurers were the largest investor segment in the cat bond and ILS market back in the mid to late 1990’s. You would have thought that they had enough risk on their books, but by careful selection of ILS investments as a diversifier to the risk they retained, a cat bond investment made a lot of sense for them. Reinsurers made up around 65% of the ILS investor base in 1997 according to data recently published by GC Securities in a presentation to the Casualty Actuarial Society.
Reinsurer participation has been on the decline ever since, partly because many of the ILS fund managers today came from reinsurance industry backgrounds and a number of funds were set up with reinsurer backing. How much of the dedicated ILS managers funds comes from reinsurers today is unclear, but it’s likely to mean they account for more than the 8% GC Securities data has them at today.
Pension funds are often cited as a big investor in the ILS space, but the reality is that they only make up around 9% of the investor base today according to GC Securities data. Again, pension funds definitely have capital in many of the dedicated ILS managers funds so that number is in reality higher we assume. Pensions funds involvement in the space has doubled over time according to the GC Securities graph. This growth is likely to continue as pension funds have a particularly long research period before they commit to a new asset class. In particular, Asian pension funds can spend five years researching a sector before committing. Another issue for some pension funds (again, particularly Asian) is that their target returns are lower than the ILS space generally offers and what they are really looking for is a stable diversifier with low volatility. With this goal in mind the dedicated ILS funds are often a much better investment opportunity for pension funds.
Hedge funds are the type of investor that has declined most in recent years due to the financial crisis. This saw hedge funds become much more opportunistic within the ILS space, only choosing to invest in the best opportunities on offer. Many of the hedge funds who were involved in ILS investment moved over to the collateralized reinsurance space, seeking the higher returns and using this as a source of investment capital. In some ways, if a hedge fund wants to be involved in reinsurance and risk, then operating a collateralized reinsurer is a better fit than investing in cat bonds because of the benefits of a new source of capital for their investment side.
Geographically the investor base is changing as well. GC Securities says that around 50% of the investor capacity base is North America based, 45% in Europe and 5% in Asia.
GC Securities says that the North America investor base is largely hedge funds, traditional managers and life insurers and that North American interest is becoming more active. Much of the inflow in North America is from alternative strategies of traditional investment managers, seeking relative value, yield and diversification. The North American risk appetite for ILS is varied, ranging from conservative for life insurers to aggressive for hedge funds.
European investors are active in the space, with a lot of input from dedicated ILS managers here. Inflows to the space are thought to be stable, with a three to five-year outlook and often pension related. The risk appetite in Europe for ILS is for mid to high single digit returns GC Securities believes.
GC Securities single out the Middle East and highlight it as an area which is becoming more active in ILS investment. Much of the inflow of capital from this region is sovereign wealth fund sourced and generally opportunistic. Interestingly, the risk appetite for ILS in the Middle East is said to be high, with 20% or higher returns sought. This would generally point towards these sovereign Middle East investors being better suited to the collateralized space than cat bonds.
Asia Pacific, GC Securities believe, has a highly active ILS investor base (albeit small still). Inflows are very stable and conservative, with yields and fees being at the forefront of motivations to commit capital to the space. These institutional investors have strong distribution networks, which if the ILS space takes off in Asia could help it grow access to capital quickly. The focus on yield is increasing in Asia Pacific, but low volatility remains key for these investors.
Some fascinating insight there into the make-up of the ILS and cat bond investor base. It’s interesting to see where growth has come from in recent years. Asia Pacific and the Middle East should both be watched closely as they could contribute huge sums of capital to the ILS and reinsurance space if the opportunities meet their motivations.
You can see the changing investor base of the ILS and cat bond market over time in the chart below: