ILS investors assess where to deploy capital as tide turns: Hiscox Capital Partners
As property catastrophe pricing softens, the next phase of the ILS cycle could put greater emphasis on manager discipline while encouraging investors to look at how public and private instruments can work together within portfolios.
After several years in which favourable market conditions have supported the sector, Liz Breeze, head of Hiscox Capital Partners, believes a softer environment will provide a more meaningful test of investment strategies.
“Strategies look good in strong markets, no matter who you are,” Breeze told Bermuda+ILS ahead of ILS Bermuda Convergence, held October 12-14. “When the cycle begins to turn, this phase in the cycle, which we find ourselves in now, is when you need an experienced investment manager with a proven track record to be able to deliver.”
Property catastrophe is accustomed to moving through pricing cycles; the challenge isn’t reacting to softening itself, but maintaining risk-adjusted return discipline as opportunities change.
For investors, particularly those focussed on opportunistic strategies, that could mean accepting that capital should not necessarily remain fully deployed throughout the cycle: “We’re very comfortable returning capital to investors if opportunities no longer meet their risk-adjusted return requirements,” Breeze said.
Capital can then be increased again when the opportunity becomes more attractive. “Then our low and medium risk portfolios are constructed with the objective of being capable of navigating different phases of the cycle rather than optimising for prevailing conditions alone.”
The changing environment also puts greater emphasis on alignment between investment managers and their capital partners, particularly where investors can see how managers are approaching the same risks with their own capital.
“I think for me the word is ‘trust’. If your capital partners know you are putting your own chips on the table alongside them, and have transparency into how you are managing your particular strategy, it gives them confidence that you are aligned, sharing the same risks and working towards the same goal,” Breeze explained.
Alongside that focus on discipline, another shift is taking place in how some investors access catastrophe risk. Breeze said there has been increased interest in blended portfolios combining private ILS, with publicly traded catastrophe bonds.
Rather than view the two as competing routes into the asset class, combining them can allow investors to draw on their different characteristics within a single portfolio. “It provides liquidity to the investor. It allows them to access the cat risk exposures they’re looking for, while at the same time having a part of their portfolio they can draw upon when they need liquidity, while still benefiting from the increased spread opportunity that private ILS offers.”
The approach therefore offers a potential balance between liquidity and spread while maintaining the underlying catastrophe exposure sought by the investor.
It also reflects a wider move towards portfolio construction based on individual investment objectives rather than predetermined products.
Breeze said investors are increasingly engaging in “objective-led multi-strategy conversations”, with considerations including target returns and liquidity preferences. “No investor is the same. They’re all entering our asset class with slightly different objectives,” she said.
That variation means there is no single appropriate blend between public and private ILS, or between different risks. Instead, Breeze argued that portfolio construction needs to begin with what an investor is seeking from the asset class.
Investor interest in the sector remains broad. Breeze said allocations are coming both from existing investors increasing their commitments and new participants entering the sector, while some are also changing what they want their portfolios to achieve.
Interest is evident across different structures and jurisdictions. She pointed to strong interest from investors attracted by the Lloyd’s framework, while saying appetite for Bermuda-based opportunities remains firmly present.
The combination of additional capital and softening market conditions, however, makes the focus on risk-adjusted returns particularly important. Growth in available capital does not necessarily mean it should all be deployed if pricing no longer adequately compensates investors for the risks assumed.
As market conditions evolve, the ability to move between structures and construct portfolios around different objectives could therefore become increasingly relevant alongside underwriting discipline.
Research, analytics and portfolio insight also plays an important role as the risks underlying those portfolios change. “We’re living in a world that continues to change and evolve rapidly,” Breeze said. “Making sure we stay abreast of that changing dynamic in terms of where risk presents itself is absolutely key.”
For ILS investors, the softer phase of the cycle might consequently be less about finding an entirely new source of returns than deciding how much risk to take, where to take it and how different forms of ILS can work together within the same portfolio and ultimately who you trust to manage it.
Did you get value from this story? Sign up to our free newsletters and get stories like this sent straight to your inbox.
