Investing in ILS the right decision. Buying every cat bond less advisable: Icosa

While allocating capital into the insurance-linked securities (ILS) sector is “certainly the right decision for asset allocators” at this time, manager Icosa Investments cautions that with some challenges in the sector it is not advisable for cat bond fund managers to buy everything in the asset class.

Icosa Investments commented on some of the “challenges we currently see in the market, of which there are quite a few,” which its CEO Florian Steiger highlighted in a recent presentation.

First, the cat bond fund manager highlights the fact numerous aggregate catastrophe bonds have seen their attachment deductibles eroded, in some cases significantly.

“Aggregate cat bonds are on track for a potentially disastrous Q2 if further tornado losses occur, adding to the attachment erosion already caused by Helene, Milton, and the recent LA wildfires,” Icosa explained.

Also highlighting what it perceives as potentially mispriced bonds, saying, “FloodSmart bonds appear aggressively priced in light of recent NFIP loss estimates.

“At these valuation levels, we see limited upside in the more junior layers.”

Finally, the investment manager also said, “Additionally, it’s concerning to see some weaker structures re-emerging in the primary market with apparently plenty of demand purchasing these bonds.”

Given the very high-demand for cat bond investments right now and the strong price execution seen, there is some evidence of broader terms being reintroduced in some recent cat bond deals. While these are currently being absorbed by market demand, Icosa is not the first to comment on them and they certainly aren’t proving attractive to everyone.

But, as the cat bond investor base is broadening at this time, there does seem appetite for more of these aggregate and lower-layer risks in cat bond form currently.

Icosa Investments concluded, “All of these factors underscore a simple truth: Whilst “buying into the asset class” is certainly the right decision for asset allocators, “buying everything within the asset class” is certainly not advisable for cat bond fund managers.

“Instead, actively managing a fund’s capacity to stay flexible and employing a data-driven investment approach are vital to reducing the risk of disappointment.”

All of which raises two considerations.

The expansion of the ILS investor base and diversification within types of managers and allocators, especially those accessing cat bonds directly (such as hedge funds and multi-managers) is positive for the sector, while diversity of offering type and structures available is also good for the market.

But this can’t be at the expense of discipline, which needs to remain firmly in-focus for managers and investors at all times.

But a further consideration, or thought that might be relevant, is whether the market could begin a slight divergence of sorts, with a cohort of fund managers and investors looking for higher-layer peak nat cat exposure, while some others want the liquidity and securitized benefits of a 144A catastrophe bond but are happier to take on more exposure, especially at lower-layers of the tower and on an aggregate basis.

If the aforementioned discipline is maintained, then more of a divergence between longer-standing cat bond investment manager-led strategies, and those of newer entrant allocators that invest directly, could actually become a welcome-feature for the catastrophe bond market, helping to extend the reach of cat bonds within global reinsurance towers.