We’re starting to hear rumblings from a number of insurance-linked securities (ILS) and catastrophe bond investors that the high volume of cat bonds brought to market this year is beginning to have an impact on ILS funds and investors ability to diversify their portfolios. The speed with which new deals have appeared and the appetite to invest in them means investment managers have had to then look retrospectively to their portfolio and the secondary market to trade their way to diversification.
2012 cat bond issuance has become a little U.S. hurricane top heavy with the addition of a number of large U.S. wind exposed cat bonds in recent weeks. While these have all been cleverly structured so as to offer some level of diversification, it isn’t always enough, particularly for some of the smaller funds who at times can struggle to get in on all of the new transactions due to demand from larger investors. We’ve heard from one smaller ILS fund who are becoming concerned about their over-exposure to U.S. hurricane risks, right at the start of the hurricane season, and a number of other funds have expressed a desire to see new cat bond and ILS deals which offer diversification this summer to make their jobs easier.
The job of diversifying your ILS fund portfolio becomes much more time consuming when opportunities are either more scarce or harder to gain access too. The secondary market alone is not enough to allow proper diversification as the best diversifying positions are often held onto and the bonds with more liquidity tend to be U.S. hurricane exposed anyway. The market could really do with some real diversification opportunities right now, perhaps in the form of Japanese typhoon or earthquake, another California quake deal from the CEA, European windstorm cat bonds or even some life, health, longevity or mortality insurance-linked security deals. Potential sponsors take note, there is growing appetite for diversifying deals meaning investors may be willing to accept slightly lower coupons for these types of risk, that could make issuance during the next few months more cost-effective.
Even investors the size of Swiss based ILS fund manager Clariden Leu, whose ILS team are soon to move to a new home at LGT Capital Management, say that they would welcome a few transactions that are not exposed to U.S. hurricanes. In recent weeks they have been selectively investing in new cat bond issuances, always with one eye on the diversification of their funds and say that their main focus continues to be on maximising returns for the funds risk level while improving the diversification and level of investment of the portfolio. In the coming months they expect to concentrate on developing the portfolio composition so as to improve the diversification of their ILS funds.
Clariden Leu also said that they have heard of a few non-U.S. hurricane ILS or cat bond transactions in the pipeline and planned for issuance in the summer months. We’ve heard similar from our sources, with mention of European windstorm as one type of risk likely to come to market, discussion of another cat bond from the CEA and talk of Japanese risks being on the agenda.
With the slowing down of the cat bond market and almost certain cessation of any U.S. hurricane exposed deals, this summer should give the market a chance to breathe and reflect on the rapid issuance seen so far. If a number of diversification opportunities come to market they will be welcomed with open arms by investment managers looking to further optimise their portfolios. It’s encouraging to hear that the forward pipeline contains at least discussions of such transactions.