The Eurekahedge ILS Advisers Index gained 0.92% in 2019, following two consecutive years of losses during which ILS fund managers with catastrophe risk exposure suffered from the damage caused by the Atlantic hurricane seasons. Despite being a period of calm insurance losses, 2019 saw ILS fund managers languishing under loss creep from upward adjustments in estimated losses of past events. Insurance-linked securities (ILS) hedge funds trade in instruments whose values depend on insurance loss events. The majority of these instruments are reinsurance policies that assume the risk taken by insurance companies, which in turn assume the risk taken by individuals or institutions. A reinsurance policy allows a second insurer to take a share in the potential profit and loss from the underlying insurance policy. The ILS market covers the reinsurance of various types of risk, including life insurance risk, catastrophic risk and debt risk. Life reinsurance ILS protects the insurance companies against extreme events that cause the deaths of a massive number of people, such as terrorist attacks, epidemic, or natural disasters. On the other hand, debt reinsurance ILS covers the potential losses caused by debt defaults.
Figure 1 below compares the performance of the Eurekahedge ILS Advisers Index and the Eurekahedge Life ILS Hedge Fund Composite against the global government bond market represented by the Merrill Lynch Global Government Bond Index, as well as fixed income hedge funds. The Eurekahedge ILS Advisers Index, launched in 2012, is an equal-weighted index designed to help institutional investors in tracking the performance of hedge fund managers who have at least 70% of their portfolio invested in non-life risk. The Eurekahedge Life ILS Hedge Fund Composite is a custom equal-weighted index comprising ILS hedge funds which primarily focus on life risk.
Figure 1: The Eurekahedge ILS Advisers Index performance since inception
As observed in Figure 1, both life ILS and non-life ILS hedge funds have managed to outperform the global government bond market over the period starting from end-2005. The Eurekahedge ILS Advisers Index has generated 4.32% annualised return since its inception, trailing behind the Eurekahedge Life ILS Hedge Fund Composite which returned 8.82% per annum over the same period. Both indices have exhibited very low levels of correlation against the global government bond market and other traditional hedge fund strategies.
Table 1: Table 1: Performance in numbers – Eurekahedge ILS Advisers Index vs. global equity and bond markets
Eurekahedge ILS Advisers Index |
Eurekahedge Life ILS Hedge Fund Composite |
Merrill Lynch Global Government Bond Index |
Eurekahedge Fixed Income Hedge Fund Index |
|
|---|---|---|---|---|
2006 |
8.68% |
14.34% |
0.88% |
8.42% |
2007 |
13.22% |
10.91% |
3.93% |
5.12% |
2008 |
3.83% |
8.71% |
8.88% |
(10.99%) |
2009 |
8.99% |
12.57% |
0.86% |
25.10% |
2010 |
7.52% |
10.67% |
3.64% |
12.98% |
2011 |
(0.14%) |
7.19% |
6.09% |
4.41% |
2012 |
5.93% |
8.51% |
9.08% |
11.69% |
2013 |
7.61% |
10.05% |
(4.67%) |
5.89% |
2014 |
5.42% |
8.11% |
8.37% |
4.44% |
2015 |
4.24% |
9.42% |
1.22% |
1.05% |
2016 |
5.19% |
7.30% |
2.96% |
6.71% |
2017 |
(5.60%) |
4.29% |
1.16% |
6.54% |
2018 |
(3.92%) |
4.94% |
0.99% |
0.18% |
2019 |
0.92% |
7.65% |
5.39% |
7.94% |
2020 year-to-date |
0.62% |
0.03% |
2.03% |
0.82% |
3-year annualised return |
(2.82%) |
5.49% |
3.44% |
4.76% |
3-year annualised volatility |
5.71% |
1.94% |
2.95% |
1.73% |
3-year Sharpe ratio (RFR = 2%) |
(0.84) |
1.80 |
0.49 |
1.59 |
5-year annualised return |
0.12% |
6.52% |
2.30% |
4.55% |
5-year annualised volatility |
4.56% |
1.68% |
3.17% |
2.09% |
5-year Sharpe ratio (RFR = 2%) |
(0.41) |
2.68 |
0.10 |
1.22 |
10-year annualised return |
2.59% |
7.69% |
3.49% |
6.06% |
10-year annualised volatility |
3.66% |
1.45% |
4.13% |
2.57% |
10-year Sharpe ratio (RFR = 2%) |
0.16 |
3.93 |
0.36 |
1.58 |
Source: Eurekahedge
Table 1 provides the detailed risk return statistics of the four indices shown in the figure above. Key takeaways include:
- The Eurekahedge ILS Advisers Index was up 0.92% in 2019, as ILS fund managers focusing on cat bonds suffered loss creep from upward adjustments in the estimated damages of past events. The index was down 5.60% and 3.92% in 2017 and 2018 respectively. Life ILS hedge fund managers on the other hand have returned 7.65% in 2019, outperforming their non-life ILS peers and the global government bond market.
- Looking over the last three and five year periods, non-life ILS fund managers have failed to generate competitive annualised returns compared to their life ILS peers and other hedge fund strategies. This is largely caused by the significant losses they suffered during the Atlantic hurricane seasons of 2017 and 2018, which wiped out nearly two years’ worth of gains and sent the value of the Eurekahedge ILS Advisers Index below its February 2015 level.
- Over a longer period of 10 years, the Eurekahedge ILS Advisers Index has recorded an annualised return of 2.59% and a Sharpe ratio of 0.16, which compares to the 7.69% return per annum and 3.93 Sharpe ratio generated by the Eurekahedge Life ILS Hedge Fund Composite over the same period.
Table 2 provides the correlation values between the performance of ILS fund managers against the government bond markets and fixed income hedge funds. As seen in the table below, both the Eurekahedge ILS Advisers Index and the Eurekahedge Life ILS Hedge Fund Composite are very weakly correlated to the two other indices, supporting the idea that ILS investments are able to provide market-uncorrelated returns for an investor’s portfolio. On the other hand, life ILS hedge funds exhibit a fairly strong correlation against their non-life ILS peers.
Table 2: Correlation matrix
Source: Eurekahedge
Figure 2 provides the 12-months rolling alpha of the Eurekahedge ILS Advisers Index and the Eurekahedge Life ILS Hedge Fund Composite against the Merrill Lynch Global Government Bond Index, assuming a 0% risk-free rate. As the figure below shows, life ILS funds typically generate higher excess returns over the government bond markets as opposed to non-life ILS funds.
Figure 2: 12-month rolling alpha of ILS hedge fund strategies against global government bonds
Figure 3 provides the performance distribution of all ILS hedge funds in the Eurekahedge database, including funds solely investing in catastrophe risk, as well as those focusing on life risk. The devastating losses incurred by the Atlantic hurricane seasons of 2017 and 2018 resulted in some of the greatest performance dispersion within the ILS hedge fund industry, leaving the bottom 10% of these fund managers down at least 17.67% in 2017, and 8.90% in 2018.
Figure 3: Performance distribution of ILS hedge funds
The last part of this strategy profile report takes a look at the ILS hedge fund industry size and asset flows over the last few years. The ILS hedge fund industry has grown from an estimated US$29.0 billion of AUM back in 2010 to US$94.4 billion by the end of 2018, before slipping to US$90.1 billion by the end of 2019. Despite the performance-based losses suffered by ILS fund managers in 2017 and 2018, the industry saw strong investor inflows which more than compensated for the losses. This trend reversed in 2019, during which US$6.2 billion of net redemptions were registered by the industry in spite of positive performance growth.
Figure 4: Annual asset flows and AUM of the ILS hedge fund industry
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