‘Time to seek high ground’: cat ILS makes strategic allocation case

Catastrophe insurance-linked securities (ILS) should no longer be regarded as a niche alternative investment but as a strategic allocation capable of competing directly with traditional fixed income, according to Bob Smith, president and co-CIO of Sage Advisory.

Speaking on a panel at ILS Bermuda Convergence, held October 12-14, Smith made a compelling case for the asset class against a backdrop of growing concerns over lower-quality private credit, equity market concentration and the reliability of traditional portfolio diversification.

The session also featured Nick Ashmore, deputy director and CIO, International Monetary Fund (IMF); Joseph Pursley, head of insurance distribution, Americas, Nuveen; and moderator Louay Mikdashi, head of multi-sector private credit at Neuberger Berman.

From an economic cycle perspective, Smith questioned the attractiveness of lower-rated credit as borrowers contend with elevated financing costs and uncertainty over the economic outlook.

“So, from a timing perspective, I think now is not the time to extend your credit allocation to the lower echelons of credit. I think it’s time to go to high ground.”

For Smith, catastrophe ILS presents an opportunity for investors reconsidering their allocations: “No longer are we to consider this a niche market. We think that the cat ILS market should be considered a strategic allocation,” he told delegates.

Drawing on a decade of performance data from the Swiss Re catastrophe bond index, Smith argued that the asset class had delivered superior results to several conventional fixed income categories.

“This is an asset class that has beaten everything on this page for the last decade, not only in gross returns, but on a risk-adjusted basis, lower standard deviation, lower volatility,” he said.

Smith also pointed to the relatively small size of the catastrophe ILS market compared with private credit, alongside the substantial global insurance protection gap, as reasons for optimism about its growth potential.

The discussion also explored whether conventional approaches to diversification remain effective as equity and fixed income markets become increasingly exposed to common economic and technological drivers.

Ashmore acknowledged the attraction of ILS in an environment where traditional asset class correlations have become less dependable.

“You’re seeing fixed income and equities move together,” he said, referring to changing correlations during periods of market stress.

However, Ashmore also raised a potential complication for ILS investors.

“One of the risks with ILS is it will be a source of liquidity when people need it,” he observed, highlighting the possibility that investors could turn to their ILS holdings to raise cash during broader market disruption.

The competitive landscape for institutional capital is also changing as investors expand their definition of private credit beyond direct lending.

Pursley cited a survey of more than 200 US institutional investors, in which 75% indicated plans to increase private fixed income or private markets allocations over the next five years. Among insurance respondents, 50% identified diversifying private fixed income exposures as their leading priority.

For Smith, however, the attraction of catastrophe ILS extends beyond its historical performance. Its exposure to insurance risk rather than conventional corporate credit or equity market drivers offers an alternative source of return at a time when he believes financial markets face heightened vulnerability.

“You think you’re getting diversification in private credit, private equity, listed markets, and so forth. In actual fact, when it hits the fan, you’re not,” he warned.

“I’m looking for something that goes left when everything else goes to the right.”

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