Cat bonds still favourite, conviction rises on private ILS & retro investments: K2 Advisors

Despite the recent spread widening seen in catastrophe bonds, K2 Advisors, the hedge fund focused investment management unit of Franklin Templeton, continues to favor the insurance-linked securities (ILS) asset class and cat bonds in particular remain its top-pick sub-strategy, while its conviction on private ILS and retrocession has risen.

When it comes to ranking asset class sub-sectors, K2 Advisors does this across a range of alternative and hedge fund strategies using a conviction and type of investment weighting, giving a score as to how it might recommend a strategy and its weighting within portfolios.

For yet another quarter, the investment manager keeps catastrophe bonds right at the top of its list.

In addition, K2 Advisors has raised its sentiment on private ILS, so collateralized transactions and privately placed ILS or reinsurance securities, and also on retrocessional reinsurance investments.

Cat bonds have a z-score of 2 which is flat with the prior quarter, private ILS transactions have risen from a z-score of 1.4 to now 1.8, retrocession has risen from 1.6 to 1.8, and these are the top-three recommended sub-sector strategies, in K2 Advisor’s opinion.

The recent mid-year reinsurance renewals showed improved conditions in private ILS and retrocession, with increased opportunities available, stable terms and still elevated rates available.

On ILS as an asset class, K2 Advisors states, “We continue to favor the sector given its attractive yield potential in addition to cleaner structures and underlying terms and conditions.”

This is despite the reversal of spread tightening, turning into widening and the fact that even resulted in some cat bond deals being withdrawn before the mid-year.

“This widening has not prevented new issuance from breaking records and setting new highs, with monthly and quarterly as well as issuance for the first half of the year, all coming in ahead of schedule,” the K2 Advisors team explained.

“During this time frame, we have witnessed more than a handful of new sponsors seek multi-year capacity via the catastrophe bond market. However, the current environment has deterred a couple of sponsors from issuing their initial offering(s), as a recently placed transaction priced toward the wide end of guidance, if not outside,” they continued.

But they see no signals there will be any meaningful slowdown, with activity expected to pick up again after the wind season.

K2 Advisors said, “We think this trend is likely to slow down, and perhaps experience a reversal, as the pipeline ceases ahead of the wind season. At the time of this writing, there are only a few deals currently on offer, with another being announced in the coming weeks.

“We remain constructive on the sector and look forward to the potential for participating in another record-setting year.”

While K2 Advisors conviction remains at the highest level for catastrophe bond investments and is rising for private ILS and retrocession, its conviction on industry-loss warranties (ILW) has dropped slightly (from a z-score of 0.2 to 0.1), while it remains low for life insurance securitization assets (at -1.3).