(MENAFN- ValueWalk) It's been a turbulent time to be in the hedge fund business during the past few years. But one class of hedge funds that's had more success than most are those funds with a focus on insurance linked securities (ILS).
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According to data from hedge fund data provider , insurance linked securities hedge funds delivered compound returns of 15.60% versus 12.21% for the average hedge fund in the three year period ending December 2016.
However, the party now seems to be over for these high-risk vehicles.
Insurance Linked Securities: Rising losses
ILS hedge funds trade in instruments whose values depend on insurance loss events such as catastrophe bonds. The bulk 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. In recent years such securities have become extremely popular with investors. The relatively high yield offered and benign risk environment has combined to make a Goldilocks scenario of high returns and low risk.
These funds are also uncorrelated the broader market movements and have "small positive correlations to wider hedge funds which is not statistically significant. In contrast, the average hedge fund has a positive correlation of 0.780 to the SP500 which furthers helps to put in perspective the appeal of ILS strategies for investors looking for true diversifiers in their portfolios" according to Eurekahedge.
"Over the near ten year period starting from January 2008, ILS hedge funds have delivered better risk-adjusted returns compared to both the traditional market as depicted by the SP500 Index and the average hedge fund – with a Sharpe ratio of 1.33 vs. 0.32 and 0.91 for the SP500 Index and the Eurekahedge Hedge Fund Index."
Unfortunately, all good things come to an end. This year has seen some of the worst hurricanes in recent years lumping potentially huge losses on owners of ILS. Following Hurricane Harvey, Irma and Maria some analysts have predicted a way of reinsurance bankruptcies thanks to high losses.
Insurance Linked securities focused hedge funds are already suffering. The Eurekahedge ILS Advisers Hedge Fund Index was down 0.33% in August and 5.46% in September, bringing the year-to-date return into negative territory with a loss of 3.69%.
Eurekahedge concludes:
"With multiple hurricane events and the earthquake in Mexico, ILS portfolios could experience further losses as the full extent of losses is revealed. For the moment, managers with exposure to these events are taking partial to full write downs on their positions...2017 could be the worst year for ILS hedge funds in more than decade."
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