Strong ILS fund performance in August, but differences in strategy show

The month of August saw insurance-linked security (ILS) funds deliver strong performance, with their best average monthly return so far this year thanks to below average hurricane activity and seasonal spread tightening, according to the Eurekahedge ILS Advisers Index.

The Eurekahedge ILS Advisers Index is an equally weighted index which tracks the performance of 30 constituent ILS funds, providing a broad measure of the performance of underlying hedge fund managers who exclusively allocate to insurance linked investments.

The average ILS fund saw performance of 0.86% in August, the highest single months performance since December 2012. This lifted the performance of the Index to 4.68% for the year-to-date.

August typically sees ILS fund performance accelerate, as seasonal price rises on catastrophe bonds boost investment managers returns. At the same time many collateralized reinsurance contracts deliver the bulk of their performance during the peak hurricane season months, meaning that again ILS fund performance can be lifted, as long as the weather remains benign.

The cat bond market, as measured by the Swiss Re indices, saw performance of 1.07% for the Swiss Re Cat Bond Price Return Index and 1.77% for the Total Return Index. The strong total return performance of the cat bond market has helped cat bond focused ILS funds to a healthy monthly return in August.

Stefan Kräuchi, founder of ILS Advisers, explained; “Performance for August was quite good on the back of a strong showing for the cat bond market. With 0.86%, August was the best month for this year.”

Both the cat bond only ILS funds and the ILS funds which also focus on private transactions or collateralized reinsurance performed well in August, with little difference between the two groupings. Kräuchi said; “There was no big difference between cat bond only funds (+0.80%) and the group of funds in the Eurekahedge ILS Advisers Index that include private ILS (+0.89).”

The two factors, of a benign Atlantic hurricane season combined with seasonal spread movements creating a rise in value on U.S. hurricane cat bonds contributed a lot to ILS funds August performance. If Atlantic conditions continue to be benign through the last few days of this month it will help ILS funds to another attractive month in September.

Kräuchi explained some factors influencing hurricane season activity; “So far the hurricane season has been extraordinarily benign with Humberto, the first hurricane only developing on September 11th. There are two main reason for the below average season: The air above the Atlantic is drier than usual and the presence of dust from Africa, known as Saharan Air Layer. Both factors make the atmosphere more stable and the second factor additionally reduces the sea surface temperature.”

On the seasonal movement in cat bond prices, Kräuchi said; “The strength in the Swiss Re Cat Bond Price Index is the result of spread tightening on US hurricane cat bonds, in line with the expected seasonal pattern, whereby bond prices firm during the corresponding risk season.”

ILS fund performance last month, as measured by the Index, was in the top 50% in a historical comparison for the month of August.29 out of the 30 constituent funds in the Eurekahedge ILS Advisors Index reported positive returns, with just one ILS fund reporting a negative for the month.

Interestingly, one ILS fund saw negative performance due to one of the hailstorms that affected Germany in July, which we suggested might impact the ILS or collateralized reinsurance market in recent articles on the event here and here. This one fund must have been impacted by a contract written for property cover in Germany, potentially having taken a layer on a large reinsurance program for a European insurer.

August really demonstrated the range of performance that is possible between different ILS funds. ILS Advisers said that the top performing fund for August, of the 30 it tracks, saw performance of 4.25% for August. This is a fund which invests across the reinsurance spectrum, not just in cat bonds.

The difference between the top performing fund and the bottom performing (so the one suffering the German hail loss) was a massive 6.24% we understand. That means the fund hit by the German hail found itself down -1.99% for the month of August, a big hit from a single hail event.

So August ILS fund performance gives us a great example of just how diverse ILS fund returns can be, 4.25% return in a single month shows how attractive ILS investments are, and also how one event which was not thought to be particularly major at first can impact a fund so negatively.

This also demonstrates that selecting an ILS fund to allocate capital to can be tricky for investors as the best and worst performing ILS funds could well reverse next month, if a chance event happens to impact once reinsurance-linked asset particularly badly. This also demonstrates the importance of investing in ILS or reinsurance as an asset class with a long-term view.

Eurekahedge ILS Advisers Index - Tracking the average performance of 30 ILS funds (click the image for more details)

You can track the Eurekahedge ILS Advisers Index on Artemis here. It comprises an equally weighted index of 30 constituent ILS 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.