Interior non-correlation of ILS helps capital flow, provides relative value: Millette

The “interior non-correlation” of insurance and reinsurance means that the ILS market can help capital flow more smoothly from end-to-end, while investors can access relative value thanks to the diversification within the sector, according to Michael Millette.

The founder and managing partner of specialist insurance-linked securities (ILS), reinsurance and transportation focused investment manager Hudson Structured Capital Management was speaking today in Bermuda during a panel session at the Convergence 2019 conference.

Millette was discussing what makes insurance an attractive market to invest in and why at his firm Hudson Structured they see value in many segments of the global market.

He began by explaining, “It’s interesting that this asset class is not well correlated with global credit and equities, that’s been one of the attractions for institutional investors and it should be.

“But it’s also interesting that when you get inside this asset class the different parts of it aren’t well correlated with each other and that’s just a great property to use.”

Many asset classes have different sub-segments within them, but typically in most financial markets there is an almost inherent correlation between them.

However, once you dive deep into niches within insurance and reinsurance, it quickly becomes clear that diversification is rife and is in fact a major driver of the traditional market business model, something that ILS investors can also harness.

“There are two vectors,” Millette went on to explain, “One is that there’s an obvious vector for diversification. But the other is relative value, as this industry doesn’t move capital end-to-end very fluidly.”

The ILS market is renowned for its ability to bring capital efficiently and swiftly into reinsurance, in property catastrophe in particular, but Millette notes that ILS managers have a unique ability to move capital more effectively across segments as well.

He explained why capital flows can seem sluggish, “First of all, there are different regulated entities, life insurance companies and P&C insurance companies are almost always in separate legal entities and the culture of the industry is to have people in very distinct lines and disciplines of business.”

Adding, “It’s important the culture is that way, as the industry needs to marshal and deploy data, expertise and risk management in very specific ways.

“But it makes capital flows brittle.”

For Hudson Structured, investing as HSCM Bermuda, this provides an advantage because, “Being able to take advantage of the interior non-correlation and being able to move capital from sector to sector creates not only a diversification opportunity but a relative value opportunity.

“We’re excited about that and I hope our investors are excited about that,” Millette said.

John Seo, Co-Founder and Managing Principal at ILS specialist investment firm Fermat Capital Management, LLC agreed.

“What do we better than other asset classes? The internal correlation, in this asset class, is something that the broader market can only dream of.

“There’s not anywhere near this type of internal non-correlation in the broader market.”

It’s a particularly interesting distinction, as the ILS asset class is often sold to investors on its ability to provide an exposure and return that is largely uncorrelated with broader financial markets.

But when you dive into insurance and reinsurance and the various lines of business that can drive returns, it’s clear that they are also largely uncorrelated with each other as well.

As another factor that should make ILS and reinsurance investing attractive, this is something that should grow in importance over time as more ILS strategies emerge that seek to tap into different, perhaps mid to longer-tailed areas of insurance risk, as Hudson Structures does, providing increasing opportunities for end-investors to diversify within the insurance-linked securities (ILS) market.

Hear from Michael Millette of Hudson Structured Capital Management at Artemis’ upcoming New York ILS conference in February 2020. Tickets are available here.