Some ILS funds are seeing redemptions, leading to cat bond selling pressure
According to our sources, there is some buyback activity going on in the insurance-linked securities (ILS) market, which is also causing some selling pressure in the secondary catastrophe bond market and could prolong the recently observed widening of the gaps.
Artemis’ sources suggest there may be a number of ILS funds that faced relatively large redemptions mid-year, while we’re also told a large retired investor may have redeemed a number of positions in different fund management vehicles.
As always, it’s hard to pinpoint exactly what’s going on, but the underlying theme from market sources is that redemptions have taken place, which has resulted in additional selling pressure in the catastrophe bond market at this time. .
Some of the less liquid ILS and investment funds focused on collateral reinsurance or retrocession only offer investors quarterly, semi-annual or even annual redemption options, we understand, with the mid-year of these points of potential liquidity.
Investors typically need to register their redemption requests well in advance of any ILS fund liquidity window, so it’s possible that this is driving some of the activity seen at the moment.
When relatively large redemptions are made from less liquid ILS funds, it is often the catastrophe bond market that suffers.
As we reported just over a fortnight ago, the catastrophe bond market was becoming more balanced, with spreads stabilizing after a long period of widening.
But now we’re told selling pressure is about to affect cat bond prices again, with spreads likely to widen further in the short term (rather), as the market rebalances at new and absorbs a glut of secondary positions set up to sell.
While we are told that redemptions largely affect less liquid ILS, thus collateralized reinsurance and retrocession, the catastrophe bond market often ends up providing significant liquidity to meet the liquidity need.
According to our market contacts, secondary brokers have touted longer catastrophic bond name lists than you typically see, as well as larger chunks of individual catastrophic bonds than would be typical of the secondary market activity at this time of year.
We are also told that the catastrophic bond names being sold are geared towards the southeastern U.S. wind, which is typical of any sell by investors or managers, as diversification risks almost always tend to be held or sold last.
It’s unclear how much of a redemption issue this is, as it appears that a larger retirement investor is redeeming a number of allocations from different ILS managers, but also talking about redemptions from other current investors in the market right now.
We believe, however, that these buybacks are fairly evenly spread across the market, with no ILS fund or manager enjoying a greater share of the action than the others.
Secondary market prices for cat bonds are now under significant pressure, due to the glut of bonds offered for sale, although the increase in the number of maturities has helped to alleviate some of the pressure felt at the over the past few weeks.
But overall, sources expect the oversupply of catastrophic bonds in the market to be easily absorbed by the market over the coming weeks, especially as the primary issuance of catalytic bonds has now slowed for its typical summer lull.
This renewed selling pressure led to a relatively large decline in many secondary market positions, with one source citing a “sea of red” on brokers’ pricing sheets on Friday.
Indicating the extent of the price declines, the Swiss Re cat bond index fell 0.7% in its last price at the end of last week.
Of course, all of the above is just a sign of a functioning market, providing liquidity through secondary selling and prices reacting accordingly.
The redemptions are also not so surprising, as further changes in the ILS market’s investor base were anticipated at key liquidity points during the year.
This, however, creates another attractive entry or buying point in the catastrophe bond market, as prices are under pressure and there is a glut of bonds available to buy.
For any catastrophe bond fund with excess cash or the ability to generate new inflows, this is an opportune time to bolster portfolios at attractive prices and with strong potential for returns on their duration.