Diversifying assets in focus as investor fear of volatility to persist

Investors around the world continue to fear a return of the stocks and bonds volatility seen in 2022 and as a result diversifying and uncorrelated assets are increasingly being sought out, which is positive for the insurance-linked securities (ILS) asset class.

In a recent Reuters article, a range of institutional investors explained how they are more actively searching out the more uncorrelated asset classes, so investments that are not linked to equities, bond markets, or broader economic performance.

Traditional investment diversification strategies, such as the 60/40 equity and fixed income mix, were seen to fail in 2022, as both sides of the capital markets suffered big valuation declines and some investors found there was no insulation for their portfolios.

As a result of which, alternative investments that are relatively uncorrelated to broader financial market and economic conditions are once again becoming a priority for the biggest investors in the world.

This search for diversification can often benefit the insurance and reinsurance industry, with even traditional re/insurers often seen as exhibiting some decorrelation from broader economic factors and other asset classes.

But, for insurance-linked securities (ILS), catastrophe bonds and direct collateralised investments into reinsurance contracts, the decorrelation from the broader economy is far stronger.

Reuters reported that demand for asset classes that can exhibit lower correlation to the broader financial markets is set to rise, particularly as many investors continue to believe markets will remain volatile, especially while central bankers fight inflation.

“While the exact trends may shift, a volatile macro environment likely persists this year,” Jordan Brooks, principal and co-head of Macro Strategies at AQR, an investment management firm with around $100 billion of assets told Reuters.

Private asset classes have grown significantly over the past decade, with data provider Preqin having estimated them at around US $1.4 trillion as of the middle of 2022, more than tripling in a decade.

Some expect the correlation between equity and fixed income asset classes to subside by the end of 2023, Reuters reported, but other investors and managers believe this may not subside so quickly.

Erik Knutzen, multi-asset chief investment officer at Neuberger Berman, told Reuters that inflation is likely to remain comparatively high and that this could continue to weigh on stocks and bonds if monetary policy is kept tight by central bankers.

Knutzen said that his firm is seeing more demand for uncorrelated investments from investors in recent months.

“The new environment for a number of years to come is likely to have higher structural inflation,” Knutzen said. “In that environment, stocks and bonds are likely to be more correlated.”

As we reported back in March 2022, the catastrophe bond and insurance-linked securities (ILS) investment market again demonstrated its general lack of correlation and ability to deliver largely inflation-proof returns, during a time of significant capital market and equity market stress.

The cat bond fund sector was positive in Q1 2022, demonstrating the decorrelation potential for investors again, while also allowing liquidity.

The correlation story (or general lack of it) with the ILS asset class has always been one of the drivers of investor interest, inflows and market growth.

But now, with return-potential so much higher thanks to harder reinsurance pricing and much improved cat bond return potential, the fact demand for ILS and cat bond coverage is also high at a time when investors are increasingly looking for asset classes that can exhibit a lack of correlation, could be extremely positive for the market.

Each time the ILS market demonstrates its relative lack of correlation to broader financial market and economic factors, the interest of investors seems to rise.

We say a relative lack, as even with ILS there is a potential for some inverse correlation, although this has always been seen to be local in nature and short-lived, even after the biggest natural catastrophe events in the world.

Right now we are seeing near-record levels of inbound enquiries from investors and our ILS NYC 2023 conference last week had a record number of end-investors and allocators attend, all reflecting the burgeoning interest in the cat bond and ILS asset class at this time.

Now, it’s down to the ILS managers and insurance and reinsurance facilitators, to convert the high-levels of demand being seen on the investor and on the sponsor side, matching these to grow the market and take issuance to new heights.