2023 an opportunity to invest in ILS on attractive historic yields: Cambridge Associates

Independent investment management giant Cambridge Associates LLC is bullish on the outlook for insurance-linked securities (ILS) investing in 2023, believing the higher yields on offer provide a good return opportunity relative to risk. But they caution that investors should review the ILS asset class on a regular basis.

It’s sound advice from the investment giant and positive for the ILS asset class, to get such a constructive recommendation from Cambridge Associates, a company with assets under management and advisory approaching $500 billion (AuM is ~$73 billion).

The company sees diversification as important for all investors in 2023 and highlights insurance-linked strategies as one area of opportunity, that is considered more esoteric, but can deliver the less correlated returns allocators are seeking.

“Over long horizons, more diversified portfolios have delivered higher returns with lower volatility than the classic balanced portfolio,” Thomas O’Mahony Investment Director, Capital Markets Research at Cambridge Associates explains. “The combination of diversifiers that is most suitable for a portfolio depends on an investor’s specific goals and circumstances. But as we move forward into 2023, likely a period of continued macro uncertainty, we believe it is prudent to build resiliency into portfolios by using the diversity of investment opportunities available.”

Christine Farquhar, Global Co-Head of the Credit Investment Group and Joseph Tolen Investment Director, Credit Investments, both further explained Cambridge Associates constructive view on the ILS asset class, noting that it has proven out its diversifying benefits for investors by being “weakly correlated” with equities and bonds through the last 15 years.

Yields are on the rise though, having begun this pattern through 2022, partly in response to regulatory pressures and the situation in Florida, which the pair termed as “a lack of underwriting discipline” in the state.

“We expect this back-up in yields will translate into great performance,” Farquhar and Tolen explain.

Adding that, “We believe the yields on offer provide a good return opportunity relative to risk.”

But also cautioning investors to take time to do their diligence, saying they, “Clearly need to review the asset class on a regular basis, as it back-stops property against the risks of climate change and global warming.”

“More frequent weather events and more severe loss outcomes have already put upward pressure on yields to compensate investors. Managers are factoring these developments (along with increased general claims inflation) into security selection,” the pair continue.

Highlighting that, on ILS investment managers, “They are more careful selecting insurance counterparties in Florida and limiting exposure to aggregate contracts, which are more exposed to higher frequency events such as wildfires, hail-storms, and tornadoes.

“Explicit meteorological modelling and disciplined underwriting of insured risk increase our confidence in manager selection.”

All of which leads to their constructive outlook for the ILS asset class, in saying, “In short, 2023 represents a market dislocation and opportunity to invest in a diversifying asset on attractive historic yields.”

However, the Cambridge Associates view does not provide the same recommendation across the entire ILS asset class.

In short, they recommend a balanced approach of investing across catastrophe bonds and collateralized reinsurance instruments, as ILS can be complex and portfolios must be “carefully constructed to limit the tail risk from major events.”

This strategy of combining cat bonds and reinsurance is “best placed to deliver optimal reward for well-managed risk,” Farquhar and Tolen believe.

In addition, the pair seem to prefer ILS investment managers that are either independent, or well-separated from their parent insurance or reinsurance companies, saying that, “Experienced managers with transparent track records and limited conflicts with parent company balance sheets are best positioned.”

Finally, the Cambridge Associates outlook is most constructive on natural catastrophe risks, such as property catastrophe reinsurance exposures it seems, as Farquhar and Tolen note that “Man-made risks, such as cyber, shipping, and aviation losses, are generally not as well rewarded for less transparent risk.”

Overall, the outlook from Cambridge Associates is very positive and a constructive view of the ILS asset classes potential for 2023.