ILS fund diversity makes multiple ILS allocations a consideration: SIGLO research

The landscape of insurance-linked securities (ILS) fund products is relatively broad and diverse, even though the majority of ILS funds are crowded into similar sizes and target similar levels of risk, meaning that, for investors, there is value in considering multiple ILS allocations, according to SIGLO Capital Advisors AG.

In fact, analysis undertaken by Swiss based alternative asset advisory specialist SIGLO shows that there is sufficient diversity among investment choices, even within the segments of catastrophe bond and private ILS funds, to warrant the consideration of multiple ILS investment allocations within those product sets as well.

The team at SIGLO has, with the support of many of the sectors ILS managers, analysed and compared factors and metrics related to 52 individual ILS fund strategies accounting for US $27 billion in assets at the time of the study, finding that while there are commonalities, there is also a good deal of diversification available within the ILS fund sector.

ILS funds tend to be bunched into the sub-$1 billion bracket, in terms of size, with the typical open-ended ILS fund size less than US $500 million, which equates to less than 0.5% of the ILS market.

Roughly half of the set of ILS fund strategies analysed fits into a no-loss return target bracket of between 10% and 15%, with expected losses of between 2% and 4% and a Conditional Value at Risk (CVaR) of -20% to -40%.

In fact, ILS funds are generally on the smaller size, with 23 out of the 52 ILS fund strategies analysed smaller than US $250 million and 45 of the funds are below US $1 billion in size.

As a result, SIGLO concludes from its analysis that a typical ILS fund is always less than 1% market share and only a handful of strategies develop to be significantly larger than this.

The average ILS fund size in the analysed set of 52, is US $533 million, but the median is only US $288 million, with the full range of sizes spanning from US $9.4 million to US $3.7 billion.

While ILS funds are crowded into the sub-$1 billion and 10% to 15% no loss return ranges, there are other factors that make that still quite a diverse set of options for end-investors, SIGLO’s analysis shows.

There are funds with majority catastrophe bond allocations, partial cat bond and partial private ILS (or collateralized reinsurance and retrocession) allocations, and then ILS funds with majority private ILS portfolios to choose from.

With significant diversity across the levels of risk assumed and the returns therefore being offered.

Then, there are the perils focused on by ILS funds, with diversification driven by strategy and as you move towards the private ILS end of the scale, increasingly diversification is driven by market access and origination strategies.

Interestingly, when SIGLO analysed the risk metrics of the ILS funds, it found that the relationship between expected loss and gross no-loss return is fairly linear up to an expected loss value of around 7%.

SIGLO also highlights that the no-loss returns, across the ILS funds at higher EL ranges, show more dispersion than at lower EL ranges.

The investment advisor puts this down to two factors.

First, that, “the market dynamics in sourcing and pricing investment opportunities at higher EL ranges is different than at lower EL ranges.”

While secondly, “it also indicates that, from a fund management perspective, a different market access and investment decision approach is likely needed at higher EL ranges than at lower EL range.”

This is as you move further into the private ILS market, where traditional reinsurance and retrocession arrangements are transformed, made investable and consumed by ILS funds for their portfolios.

Clearly a different set of skills, in sourcing risk, as well as in analysing, measuring and pricing it, are required in the more private side of the ILS market, compared to in catastrophe bonds where syndicated placements are the norm.

This is one way managers of private ILS focused funds can generate alpha, through their contacts, as well as their underwriting market networks and capabilities.

On the peril side, SIGLO’s analysis unsurprisingly shows the US hurricane risk concentration of the ILS fund market.

On average, around 55% of the ILS funds expected loss stems from US wind exposure, ranging from a minimum of 25% to a maximum of 78% of EL.

US earthquake only ranges 5% to as much as 23% of expected loss for the ILS funds studied, while other perils make up the rest, but are subject to a broader dispersion of exposures across the ILS funds.

While it appears concentrated, it is the differences in percentage levels exposed to the perils that allow for diversification between ILS fund strategies, also allowing for ILS managers to differentiate themselves by having a different approach to risk concentration.

Then there is the scale of exposure to different transaction types and instruments, from pure catastrophe bond funds, to those focused partially on cat bonds and partially private ILS, to specialist ILS funds that only allocate to retrocession, for example.

Within that there is again a lot of diversity, with some ILS funds investing in quota shares, others excess-of-loss only, reinsurance, retro, indemnity, industry-loss triggers, aggregate and occurrence.

All of which again provides ILS fund managers with opportunity to differentiate, as well as to try and generate alpha for their investors through a differentiated and targeted strategy, or approach.

SIGLO explained, “Allocations to the Cat Bond market segment can be more concise in terms of product selection. Allocations to broader ILS funds, conversely, are more disperse across products and provide different and more complementary strategies.

“One can argue that in order to construct tailor-made ILS portfolios, addressing individual investors’ needs it is valuable to consider an allocation to multiple products across both ILS market segments.”

SIGLO has produced a fantastic piece of research and a good promotion for the level of diversity available in the ILS fund market, with a broad range of products to suit different investor’s needs.

You can access a copy of the report here.