Other Forms of ILS

A broad variety of components may be included in an ILS portfolio. “Perhaps the most important thing is to understand the full spectrum of instruments your ILS fund manager incorporates into the portfolio,” says Milliman’s Koch. “In addition to the $20 billion-plus of outstanding publicly traded securities, there is also upwards of $50 billion deployed into private reinsurance transactions by ILS funds.”

Whether publicly or privately transacted, each one is “a complex structured security,” says an official with the National Association of Insurance Commissioners (NAIC), who spoke on condition of anonymity. “Investors should pay attention to all aspects of how the security works.”

Understanding The Market

ILS investors can use alternative investment funds. These tend to be institutional and closed-end; they don’t trade on the secondary market and are largely illiquid. They can only be offered by a registered investment company. Like all mutual funds, they are regulated under the Investment Company Act of 1940.

“We’ve been noticing that there have been fixed-income mutual funds changing their restrictions to include cat bonds,” says Connelly at Versant. “Not that they’re devoted to cat bonds, but they are allowing them as an option.”

Make no mistake: These are not securities that uninformed or unprepared investors should even consider. “If you’re using this asset class, if you’re investing in one of those funds that has cat bonds as part of its palette, you want to make sure you don’t treat it like any other bond,” cautions Connelly. “You really need a manager who understands the market, the risks, the cyclicality, and so forth. A manager who will display patience and discipline with the capital. You can’t just say I’m going to put cat bonds on my menu and diversify.”

Swedroe adds that ILS investments are always for the long term. “You should never buy this stuff for the short term,” he says. “And this isn’t the kind of thing you should do in isolation. You can build a portfolio of alternative investments, all of which have low to no correlation with equity or bond markets.”

Evans at Artemis would agree. “These are [for] long-term, conservative investors, largely major pension funds, sovereign wealth funds, endowments, etc.,” he says.

Well Regulated