Fund Management

Q&A: Pioneer On Why The Insurance-Linked Securities Market Deserves Some Attention

Eliane Chavagnon, Editor - Family Wealth Report, June 1, 2015

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Here is a Q&A with Pioneer about its insurance-linked securities fund and why it may appeal to the high net worth sector.

Family Wealth Report recently spoke to Charles Melchreit, senior vice president and director of investment-grade, portfolio management, to discuss Pioneer’s approach to insurance-linked securities, an outlook for 2015 and why this asset class may make sense for some high net worth investors.

What was the genesis of the Pioneer ILS Interval Fund? Could you provide context regarding growth in the insurance-linked securities market and why Pioneer is offering a product dedicated to this asset class?   

Melchreit: Insurance-linked securities (ILS) are not new to Pioneer. We have been investing in ILS across insurance cycles since 2007 and have found them to provide an excellent source of diversification in our large, multi-sector fixed income portfolios. We managed about $1.4 billion in ILS as of March 31, 2015, making us a major player in this asset class. Many of our clients are concerned about highly correlated asset classes, as well as the current interest rate environment and are looking for alternatives to traditional strategies. While ILS have their own unique risks, they can provide investors with greater opportunity.

We believe ILS are worth considering in a dedicated fund for several reasons. First, the asset class has had attractive return characteristics relative to other asset classes. At different parts of the market cycle, ILS have typically out-yielded similarly-rated high-yield bonds over various time periods. They have a very low correlation to traditional asset classes and can potentially generate less volatile returns. Fundamentally, this makes sense because many of the securities are ultimately tied to insurable catastrophic events, such as hurricanes or earthquakes, and not to financial markets. Finally, ILS are a potential hedge for interest rate risk. The majority of event-linked securities are floating rate instruments, leaving investors with limited interest rate duration risk. While ILS have their own unique risks, they provide investors with even greater opportunity.

Can you outline the fund's overall investment strategy and how – if at all – this has changed in time?

Melchreit: Pioneer’s fund invests primarily in securities that are broadly diversified with respect to the types of risks to which they are exposed, geography and the specific terms of the securities. Specifically, it invests in catastrophe (cat) bonds, quota share instruments (also known as “reinsurance sidecars”), collateralized reinsurance investments, industry-loss warranties and event-linked swaps.

At Pioneer, we use an active, smart beta approach that seeks to minimize adverse selection and non-modeled risks. Our global fixed income and equity research teams support the portfolio management team to ensure comprehensive coverage of the insurance industry. We believe this provides unique insights into how insurance and reinsurance companies approach the transfer of risk to the capital markets and can allow for stronger long-term, risk-adjusted returns relative to a passive strategy. Our process leverages a deep team of quantitative risk analysts and sophisticated modeling capabilities. Our experience in the ILS asset class, dating back to 2007, improves our ability to evaluate and negotiate deal structures because of the relationships we have built with sponsors through the years. Pioneer’s commitment to the space, coupled with our size and ability to provide capital to the marketplace, makes us an attractive risk-sharing partner with sponsors and enhances our relationships, resulting in stronger market access.     

What is your approach to risk management?

Melchreit: The investment team incorporates an active, smart beta approach that seeks to minimize adverse selection and non-modeled risks by using our global fixed income and equity research teams to support the portfolio management team. This promotes comprehensive coverage of the insurance industry. The fund’s process is built upon a significant analytical foundation, using industry analytics to evaluate the risk of individual investment opportunities.  Pioneer invested in the analytical engine CATRADER, which is widely used within the insurance industry. This database contains crucial details on numerous catastrophes and allows Pioneer to model its peril exposures at both an individual security and a portfolio level.

We determine the desired allocation of ILS by a diversity of structures (risk layers), perils and geographic locations.  Risks are spread widely across non-correlated insurance perils (such as hurricanes, earthquakes and tornadoes) in different geographical areas. Geographic locations include North America, Asia, Europe, Australasia and other areas. In addition, the fund has various risk management checkpoints that guide decisions around geographic dispersion, liquidity and the maximum expected loss of a single event.

Are there any sector-specific opportunities in 2015?

Melchreit: As we look at 2015, we are seeing more and more ILS opportunities in non-US insurance perils.  This provides us the ability to diversify risk away from the US, which has historically dominated supply. We believe this global ILS trend is here to stay as the market expands.

What makes the insurance-linked securities market potentially attractive to high net worth investors?

Melchreit: ILS can offer high net worth investors the opportunity for a truly non-correlated asset inside of an asset allocation model. If 2008 taught us anything, it’s that equities, commodities and fixed income were all correlated, and, in a world of massive central bank intervention, we believe are likely to be correlated moving forward. However, asset bubbles and recessions do not cause natural disasters and natural disasters do not cause asset bubbles or recessions. This alone may make ILS very attractive to high net worth investors. 

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