The distorting influence of extreme monetary policy can be seen in many regions of global capital markets, not least in the obscure world of reinsurance where the combination of low interest rates and an influx of third-party capital has had a profound effect.
The attractions of catastrophe bonds and other insurance-linked securities to pension funds, hedge funds and other investors are clear. In an income-starved environment, such assets have offered relatively high yields as well as returns that are uncorellated with other asset classes.
However, their popularity has led to a supply of excess capital that has placed considerable downward pressure on reinsurance pricing.
This means that investors have accepted ever-lower returns to compensate for the catastrophe risks they are exposed to. Investors have ridden their luck, while Mother Nature has been kind to the US, but now investors face greater uncertainty given the destructive impact of hurricanes Harvey and Irma.
Although it is yet far from clear what the final cost of the recent hurricanes will be, or to what extent third-party providers of capital will be affected, the market’s initial reaction to events was swift.
The Swiss Re Catastrophe Bond Index, for instance, fell by over 15 per cent while Citrus Re 2020, a catastrophe bond issued by Heritage Insurance earlier in the year, saw its price decline by nearly 50 per cent, according to Bloomberg.
Third-party capital will continue to play an important role in the reinsurance industry but, as was ever the case, uncertainty and illiquidity make for poor bedfellows.
We prefer to gain exposure to the insurance industry through the Polar Capital Global Insurance fund. Managed by Nick Martin, the fund offers investors exposure to specialty property and casualty companies such as Chubb, Arch Capital and Markel, covering a diverse range of areas from medical malpractice and healthcare insurance, to crop and mortgage insurance.
These companies provide insurance products that are often required by law and constantly in demand, whatever the macroeconomic backdrop.
The Polar Capital investment process eschews insurers that take excessive risks and focuses on those with a track record of disciplined and profitable underwriting.
The interests of management of the companies, which Polar Capital prefer, are closely aligned with investors through both significant share ownership and a focus on generating high returns on equity.
This has resulted in business being written when insurance premiums are attractively priced and capital being returned to shareholders when they are not.
Indeed, the portfolio’s exposure to the catastrophe reinsurance market has fallen significantly over the last few years as the fund’s underlying holdings have shunned the lower returns on offer. Instead, a number of the portfolio’s constituents have benefited from buying reinsurance at a lower cost.
The Polar Capital team’s patient and sensible capital allocation has made for handsome returns. From inception in 1998, the Global Insurance fund has generated a compound return of 9.9 per cent a year, (net of fees), closely tracking the growth rate of the portfolio’s underlying book value, while comfortably outperforming the 6.7 per cent annualised return generated by the MSCI World (GBP) (according to Bloomberg).
