2024 still an attractive entry point for insurance-linked securities investors: K2 Advisors

Despite some tightening of spreads in catastrophe bonds, overall K2 Advisors, the hedge fund focused investment management unit of Franklin Templeton, remains overweight the insurance-linked securities (ILS) asset class, although finds industry-loss warranties (ILW’s) relatively less attractive at this time.

Positively, K2 Advisors notes that while private ILS investments, such as collateralized reinsurance and retrocession, have faced challenges, some capital is expected to flow to the managers with the best track-records.

But, even with this, K2 Advisors says the private ILS segment may still be capital constrained, overall, suggesting rates have a greater chance to remain elevated.

Giving its outlook for the first-quarter of 2024, the K2 Advisors hedge fund team state, “Following a record year of new issuance, the catastrophe bond market spread is elevated relative to historical levels, despite tightening throughout the year. We believe it remains an attractive entry point.”

They expect January reinsurance renewal pricing to have shown continued increases, year-on-year, while in the cat bond space they say, “We expect an active and attractively priced new issuance pipeline throughout the first half of 2024.”

Adding that, “We continue to overweight insurance-linked securities due to the diversification they can provide, along with a yield pick- up and idiosyncratic risk/return profile.”

Going into more detail, K2 Advisors highlights the record issuance and market size indicated by Artemis’ data on the catastrophe bond market.

The investment manager comments, “The combination of increasing investor demand for more senior insurance-linked securities (ILS) risk and higher total insured values, likely due to economic inflation, have led the catastrophe bond market to reach its largest size on record. While catastrophe bond pricing tightened throughout 2023, we are seeing signs of price stabilization.

“When coupled with a meaningful collateral return, we believe this provides an attractive entry point for investors into the catastrophe bond market.”

On the private ILS side, the improvements in price achieved at the January reinsurance renewals will play into, “increasing the risk adjusted price improvements the markets experienced during the January 2023 renewals,” K2 Advisors suggest.

Going into more detail to explain, “Given the strong performance across ILS risk segments throughout 2023, we expect some level of new capital to enter the market. On the private ILS side, we expect capital to gravitate toward managers who have demonstrated suitable loss-reserving policies. There will likely continue to be a supply/demand imbalance across private ILS strategies, with cedants retaining more risk on their balance sheets. Subsequently, this implies more volatility and lower-down loss exposure as many frequency losses may not be able to be hedged.”

Overall, K2 Advisors remains overweight the insurance-linked securities (ILS) asset class as a whole.

While this has been revised down from strongly overweight at Q4 2023, it’s important to note that the only segment of ILS that has actually been revised down is industry-loss warranties (ILW’s), which was taken down from strongly overweight, to overweight.

K2 Advisors outlook remains strongly overweight for catastrophe bonds, private ILS transactions and retrocession, while its position on life ILS remains underweight.