Investors & consultants appreciate defensive qualities of ILS


Institutional investors and their investment consultants are extolling the defensive virtues of the ILS asset class of late, as once again allocations to insurance and reinsurance linked investments proved themselves largely uncorrelated to broader financial market contagion during the Covid-19 pandemic.

investment-growthWhile the catastrophe bond market saw selling pressure leading to some mark-to-market declines, still the fully securitised ILS market has performed far better than most comparable asset classes offering similar levels of risk and return.

In addition, the catastrophe bond market is managing its opportunities versus capital very well, to ensure important primary issuance has a chance to be aired, while also serving the needs of any investors looking to sell-down their cat bond holdings.

Meanwhile, broader collateralised reinsurance and ILS fund performance has remained strong, albeit with some marking down of positions that are threatened by business interruption claims due to the pandemic.

That’s really the extent of the impacts of Covid-19 on the catastrophe bond and broader ILS market, with mark-to-market declines expected to be recouped over the coming months once cat bond market activity levels become more balanced.

While there is a chance of larger losses for some collateralised reinsurance entities, especially those structures and funds tracking the performance of reinsurers, such as a sidecar vehicle and private collateralised reinsurance quota shares, still the overall stability of the ILS market has been high and this has not gone unnoticed.

Many in the institutional investment community are already aware of the low level of correlation exhibited by ILS during the last major financial crisis in 2008 and again in 2020 the asset class has demonstrated the same.

But for those investors that hadn’t explored insurance-linked securities (ILS) and catastrophe bonds yet, the stable nature of the asset class’ performance through Covid-19 so far is set to spread even greater awareness of the positive qualities of the ILS asset class among institutions worldwide.

Pensions & Investments highlighted insurance-linked securities (ILS) as a positive diversifying addition to pension fund investment portfolios recently.

It noted that insurance-linked securities strategies are seen as one set of opportunities which has helped to mitigate the impacts of recent market volatility on some investors portfolios, according to its sources.

“Defensive strategies implemented ahead of the coronavirus-induced global market meltdown protected institutional portfolios to some extent in the first quarter,” the article states.

Some pension investors have been well prepared for a market crisis, having established segments of their portfolios with a focus on diversifying and defensive asset classes in recent years.

For some pension funds, ILS allocations fit within this defensive and diversifying returns bucket, given their lack of correlation to broader financial market movements.

These crisis risk mitigation type strategies have helped some pension funds to better weather the recent crisis than others, with many funds down significantly as the values of their investment portfolios declined in recent weeks.

Certain hedge fund investment strategies are seen as providing returns that are relatively uncorrelated with the broader markets and ILS as well as some other reinsurance strategies fit in this bucket for some investors.

Some investors have benefited from making ILS allocations prior to the Covid-19 outbreak.

“We like ILS hedge funds and a reasonable number of our clients are invested in them because they are truly uncorrelated to the market,” Christopher Walvoord of consultant Aon Hewitt told P&I. “In a year without natural disasters, so far, these strategies have kept chugging along.”

Jonathan Francis, Head of Investment Research at Harrington Cooper, recently discusses some of the beneficial traits of the ILS asset class with Investment Week.

“Searching for alternatives that should provide a defensive and uncorrelated risk/return profile, we believe catastrophe bonds are extremely well placed,” Francis explained.

Having not been affected by the recent financial market volatility, catastrophe bonds have demonstrated their diversification benefit for investors and Francis noted that now is a good time to allocate as well.

“This comes at a time when catastrophe bond spreads are at their widest levels we have seen in over five years following the technical demand/supply imbalance they saw during 2019.”

With market spreads already wide, secondary marks pressured slightly by the recent sell-off but set to recoup this, plus recent transactions paying higher coupons and so cat bond fund yields set to increase, while reinsurance rates more broadly are rising and expected to rise further, now seems like an opportune time to add catastrophe bonds to pension fund portfolios.

The defensive nature of catastrophe bonds, ILS and collateralised reinsurance investments may only truly become evident in times of crisis.

But with the investment case currently looking extremely strong, it’s a good time for institutional investors such as pension funds to add an allocation to ILS to their risk mitigation and alternative return strategies.

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