Side pockets for Covid-19 set-up in June, as ILS funds average 0.67%

A number of insurance-linked securities (ILS) fund managers established side pockets to segregate potential exposures related to the Covid-19 pandemic in June 2020, while some ILS and collateralised reinsurance funds also suffered adverse reserve development related to prior year catastrophes as well.

But despite all of this, the average return of catastrophe bond and insurance-linked securities (ILS) funds reached an impressive 0.67% in June 2020, according to the Eurekahedge ILS Advisers Index.

Catastrophe bond funds outperformed, ILS Advisers explained to us, helping to drive the Index performance higher for the month.

In fact, at 0.67%, this is the highest June return for the ILS fund performance Index since 2011 and the fourth highest on record.

The group of ILS funds that only invest in catastrophe bonds reported an average return of a very impressive 0.8% for the month of June.

This will have been partly driven by elevated levels of return in recent issues, perhaps providing a glimpse at the quality of some cat bond portfolios at this time.

ILS Advisers reported that cat bond prices were relatively flat, with the Swiss Re Index only returning 0.53% for June, which suggests that the elevated return of cat bond funds is being driven by the higher returns of recent investment opportunities to a degree.

The subgroup of ILS funds whose strategies include private ILS and collateralised reinsurance returned 0.58% for June 2020, which is still a reasonable figure despite the side pocket activity that was seen in the period.

Overall, only one ILS fund was marginally negative for the month, while 32 of those tracked by ILS Advisers reported positive returns.

During the month, some ILS funds invested in collateralised reinsurance and retrocession contracts, saw adverse development related to prior year catastrophe events, ILS Advisers told us.

We’d already reported that among these was 2019’s Japanese typhoon Hagibis, but ILS Advisers also reports that some ILS funds saw adverse development from events including 2017’s hurricane Irma, 2018’s typhoon Jebi and also 2019’s typhoon Faxai.

ILS fund managers made adjustments to their prior year loss reserves for these events and also bolstered their side pockets.

ILS Advisors Founder Stefan Kräuchi explained to us that, “Those adjustments are made to the side pockets, which are not always included in the performance reported to the index. Some managers report the performance on a combined basis, others only the main share class.”

Also seen in June was a number of ILS fund managers taking action on potential Covid-19 pandemic exposures, setting up side pockets to segregate any investment positions that are considered to be at-risk of exposure to losses.

As we’d previously explained, the subject of how to deal with potential loss exposure to the coronavirus pandemic is a tricky one for ILS fund managers, given loss notifications have not yet been seen (as far as we understand) and there remains a significant amount of uncertainty related to global issues on business interruption and the pandemic.

Establishing new side pockets to segregate any reinsurance or retro positions considered at-risk from the pandemic is the preferred way to go, as it enables the manager to remove these from its main reportable portfolio, which will allow for new investor inflows to continue into funds without any risk of picking up Covid-19 exposure.

ILS Advisers said that “several managers” have set up these side pockets, which we’d expect all sit on the private ILS and collateralised side of the market given there is no real concern over cat bond exposure to Covid-19.

These side pocketing actions may be expected to continue through the coming months, as more ILS fund managers gain clarity and insight into potential Covid-19 exposures sitting in their portfolios.

Overall, the gap between best and worst performing ILS fund in June 2020 was 1.37%, which is actually narrower than most months, reflecting a largely profitable period for the ILS market it seems.

You can track the Eurekahedge ILS Advisers Index here on Artemis, including the USD hedged version of the index. It comprises an equally weighted index of 33 constituent insurance-linked investment funds which tracks their performance and is the first benchmark that allows a comparison between different insurance-linked securities fund managers in the ILS, reinsurance-linked and catastrophe bond investment space.