Normally by this stage of the month we have a pretty good idea how insurance-linked security and catastrophe bond funds have performed in the prior month, but this time Sandy has muddied the waters somewhat. ILS fund managers are being slower to publish their funds October returns as calculating the impact of mark-to-market losses caused by Sandy’s approach and first impact has proved tricky.
We’ve noticed in the first two updates we’ve received from ILS fund managers that the impact of Sandy on ILS funds is likely to be quite varied. A number of factors come into play, which could lead one fund to suffer a greater mark-to-market decline than another, including which catastrophe bonds they invest in, how much exposure the fund has to northeast hurricane and whether the ILS fund has other types of re/insurance contracts in its portfolio which were exposed. There is also a possibility that some mark-to-market losses on secondary cat bonds might be accounted for in October for some funds but November for others depending on processes and pricing methodologies.
So, it’s going to be a little difficult to read anything into the performance of ILS funds in October, but here’s an overview. October saw significant spread tightening in secondary cat bonds for the first three weeks of the month, had it not been for Sandy the performance of ILS funds would have been outstanding once again. However, according to Swiss based ILS manager Plenum Investments, this tightening of spreads and price rises stopped abruptly as hurricane Sandy approached the north east coast of the U.S. and the landfall probability increased.
Interestingly, Plenum Investments said that Sandy only had a slight impact on secondary market prices for October. In fact, the Plenum Cat Bond Fund actually returned an impressive 1.09% in the USD share class for the month of October, which is pretty astounding at first glance, but really just shows you that Plenum’s exposure to an event like Sandy could not be all that large. Plenum’s fund actually had a better performance in October than in September, but it remains to be seen what the impact to their November returns will be and it is possible that some of the mark-to-market losses will be picked up this month.
Plenum remain confident that none of the cat bond they invest in will suffer a loss of principal. They say that the unknowns to do with flood coverage in commercial policies and hurricane deductible questions still need to be answered, but at the moment they feel losses are unlikely. Therefore they expect any downward price movements will be recovered as the uncertainty around losses becomes clearer. Even in a worst case scenario Plenum said that Sandy would likely only cause a 0.8% impact to their fund.
So, that’s an example of an ILS fund who delivered a very good return to investors in October despite the initial impact caused by Sandy. Looking at the Eurekahedge ILS Advisers Index, which so far has only had 31% of its constituent funds report October returns, it is showing an average performance of 0.03% for October so far. Much lower than Plenum have reported. Another fund, the Insurance Linked Strategies fund from ILS manager Alternative Beta Partners, has reported a negative return of -0.10% for the month of October due to mark-to-market losses on exposed cat bonds. This really shows the variety of returns we can expect to see from October, driven primarily by the contents of each ILS funds portfolio. Interestingly, Alternative Beta Partners also said that if Sandy produces an industry loss around the $17.5 billion mark they would expect their fund to only lose between 0 and 100 basis points (or up to 1%).
It’s worth noting that Alternative Beta Partners fund has a 31% exposure to North Atlantic wind, where Plenum report a contribution to expected losses for north east wind of only 11.1%. So it’s possible that the Alternative Beta Partners fund has a much greater exposure to the cat bonds which saw the largest mark-to-market losses at the end of October.
It’s inadvisable to read too much into the variance between the reported returns. The November returns may be more telling for Sandy’s true impact as they will either see funds claw back some mark-to-market losses or if there are any principal losses we could see further impact for those most exposed to the region Sandy affected.
Update: Alternative Beta Partners told us that their exposure to northeast U.S. wind is actually much lower than 31%, as that includes all U.S. hurricane risks (so Florida etc as well). They also told us that they have fully accounted for the initial Sandy related mark-to-market losses on exposed cat bonds in their October return figure.