June 7, 2017

More pension funds invest in ILS as alternatives allocations rise: Mercer

European pension funds have been increasing their allocations to alternative investments and this looks to have been benefitting the insurance-linked securities (ILS) space, with the percentage of EU pension funds that have an allocation to ILS doubling in the last year, according to consultancy Mercer.

Mercer found in its latest survey of European pension fund investment allocations, that ILS and insurance or reinsurance linked investing is growing in popularity.

In its 2016 survey Mercer found that 1% of pension funds it surveyed had an allocation to ILS. In 2017 that has doubled, with the latest survey showing that 2% of the pensions surveyed are already investing in ILS and other reinsurance linked assets.

Meanwhile the amount that pension funds tend to allocate to investments in the ILS asset class has not changed over the last year, with on average a pension fund putting 4% of its assets into ILS investments.

Pensions have been increasingly investing in alternative assets, as they looks for additional sources of return while accepting the reduced liquidity and often greater complexity.  The average allocation to alternative asset classes has increased in 2017 to 22% compared to 21% in 2016 (which has risen from just 4% in 2008).

Phil Edwards, Mercer’s Global Director of Strategic Research, commented; “While many private markets have seen significant inflows in recent years, opportunities remain for high quality managers to extract returns in less liquid and more complex markets.”

Interestingly, Edwards said that, “This is especially true in areas where the supply of capital remains constrained,” which is of course not the case for the ILS and reinsurance market.

In fact capital remains at excess levels in ILS and reinsurance, hence rather than the increased investments being a case of supplying capital where it is most needed, this is more related to the fact that the capital efficiency in ILS can be higher than traditional reinsurance, helping the alternative or ILS capacity to displace the more traditional sources in the industry.

For European pension funds the returns of ILS and reinsurance markets are increasingly attractive, especially when so many can be considered cashflow negative and in need of a boost to their returns and income.

Mercer’s report found that pensions continue to increase their exposure to hedge funds, rising from 33% of pension investors to 37% this year, as a response to the challenging environment for traditional market investments like equities and bonds.

This increased appetite for hedge funds, alternatives and less liquid asset classes will no doubt help to drive ongoing interest in the ILS and reinsurance linked asset class, driving additional inflows in the future.

“The current outlook for traditional asset classes, however, appears more challenging, and hedge funds, with their absolute-return focus, offer an attractive proposition on a relative-value basis. In addition, we expect higher volatility and lower correlations across markets going forward, which should provide attractive opportunities for active management in general, and hedge funds in particular,” explained Des Wardle, Alternatives Portfolio Manager at Mercer.

As alternatives become increasingly important to pension funds, ILS can offer the benefits they seek from an alternative investment, with some of the lowest correlations to the other asset classes they invest in. That should help to stimulate continued interest, as awareness of ILS and reinsurance linked assets continues to grow.

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