“It is interesting but it is a completely different risk and I am not sure that investors are ready to take on that type of risk,” says Simon Vuille, co-portfolio manager at LOIM. “In our view one of the main attractions of ILS is that it is uncorrelated from the macro-economic picture and financial services. Investors have enough exposure to banks and financial services sectors in their traditional portfolios in terms of bonds and equities and they do not need any more.”
John Seo, co-founder and managing principal at Fermat Capital Management, believes that in time these different types of risk transfers will gain traction in the cat bond market.
“It is early days but like earthquakes and hurricanes, operational risk not only has good data to be analysed and modelled but also a strong regulatory environment. This allows for a sharp actuarial focus. It is a chicken-and-egg type of situation but there will be greater innovation and risk spread against the broader base of capital.”
Education will be a key ingredient but many investors, particularly those in the UK, are still on a learning curve for the traditional cat bonds.
To date, Swiss and Dutch pension funds are the most knowledgeable and in some cases the most willing to embrace new structures. The British were late to the party, but as Nick Spencer, director, client and research at Russell Investments, explains, there were a small number of early adopters in the UK but pricing has been tight for a number of years and this has held back broader cat bond adoption.
He believes, however, that cat bonds are a natural starting point for ILS investment and as institutions gain experience they will become more involved in the more complicated and bespoke ILS market.
“At the moment, liquid bonds are richly priced and I do not think they provide enough compensation to make a significant allocation. There are some interesting opportunities in the bespoke ILS market.”
