K2 Advisors raises insurance-linked securities (ILS) to “strongly overweight”

K2 Advisors, the hedge fund focused investment management unit of Franklin Templeton, has raised its conviction on investing into insurance-linked securities (ILS) and reinsurance investments to “strongly overweight” saying it anticipates firm pricing conditions and despite some spread tightening in catastrophe bonds the yields remain attractive.

K2 Advisors has had an overweight view on the insurance-linked securities (ILS) asset class for some quarters now, with catastrophe bonds seen as a particularly outstanding opportunity through the year-to-date, while its conviction on other areas of ILS, such as collateralized reinsurance and industry-loss warranties (ILW’s) has been improving throughout 2023.

K2 Advisors was already overweight or strongly overweight on catastrophe bonds, private ILS transactions and retrocession since the start of this year. It then raised its conviction on investments into the industry-loss warranty (ILW) as well, turning overweight ILW’s in the last quarter.

Now, the investment manager has turned its conviction to “strongly overweight” to the entire asset class for the first time this year, as it sees ILS offering an opportunity better than many other sub-sectors of hedge fund investments.

“Despite recent tightening, the forward-looking yield environment across most risk segments remains attractive,” the asset manager summarises its view.

Noting as the market looks towards the busy end of year reinsurance renewals that, “Initial January 1 pricing indications appear strong despite the relative lack of impactful hurricane landfalls. Catastrophe bond pricing and total yield are attractive to us despite tightening conditions throughout the year.”

In terms of macro-themes investors should be considering in the fourth-quarter of this year and beyong, K2 Advisors places the ILS asset class within these key trends.

“Insurance-linked securities are one of the most idiosyncratic investments to pick up excess yield while offering diversification to portfolios,” the manager explained.

With most ILS managers now focusing on the end of year renewals and burgeoning catastrophe bond pipeline, K2 Advisors notes that a supply and demand dislocation remains within the broader insurance and reinsurance markets, and while this is less pronounced than a year ago, it “is likely large enough for spread and pricing levels to remain elevated.”

Commenting on the outlook for end of year cat bond and reinsurance activity, “Given the increase of demand for risk transfer and relative lack of capacity in traditional reinsurance markets, we expect to see several sponsors and cedants utilize the catastrophe bond market to transfer retrocessional and reinsurance risk.

“In response to loss trends and challenging reinsurance markets, many cedants have materially shifted their portfolios since the start of 2022. In some instances, cedants retained higher levels of risk in 2023 given the severe supply and demand dislocations ahead of last year’s renewals. This will likely lead to pent-up demand for reinsurance from these cedants at higher price levels and cleaner risk from a structural perspective.”

K2 Advisors believes there is, “substantially more demand for insurance risk transfer than capacity available to take the risk.”

As a result of which the opportunity looks particularly strong, for ILS investments and other forms of capital to flow in.

K2 Advisors said, “Given the strong performance of the asset class through the first nine months of the year, there will likely be fresh capital entering the space, potentially capitalizing new startups as well as reverting to collateralized reinsurance sidecars, which had generally fallen out of favor over the last few years. There may also be more opportunistic investors who are looking to capitalize on the currently attractive reinsurance market cycle and will evaluate their potential investments on a year-to-year basis.”

The investment manager also expects the strong cat bond pipeline to keep building, with several new sponsors anticipated and as a result, “This year could be yet another one of record new issuance, eclipsing the most recent record setting years of 2021 and 2022,” K2 Advisors said.

Adding that, “While the catastrophe bond market spread has tightened throughout the year, the forward-looking market environment remains attractive, in our view, especially given it appears the Fed will keep rates higher for longer than initially forecasted.”

It is another very positive outlook for ILS from K2 Advisors, as the investment team at the unit of Franklin Templeton continues to see strong opportunities for bringing ILS and reinsurance market returns to their investors.