Multi-manager approach key to navigating ILS manager dispersion: MLC

Investors often approach insurance-linked securities (ILS) as a source of “alternative beta” exposure—something that can be accessed efficiently, often via a single manager, yet, according to Gareth Abley and Jehan Sukhla, Co-Heads of Alternatives at MLC Asset Management, that approach overlooks one of the most significant and underappreciated risks in the asset class, manager implementation risk.

In a recent paper, the pair argue that ILS investors underestimate how much performance divergence is driven not by risk appetite, but by nuanced decisions in portfolio design, a divergence made more pronounced by the unpredictable nature of catastrophe events.

“We think one of the most underestimated risks in the asset class is manager selection and portfolio design. It is intuitive for investors exploring ILS to perceive the asset class as ‘alternative beta’ and so form the view that the optimal strategy is to access this ʻbetaʼ as fee efficiently as possible,” they write.

“Additionally, given it’s a relatively small asset allocation for most investors, from a resource efficiency perspective, it’s common to go with a single manager (even though that’s unlikely to be considered as the right approach in virtually any other asset class). The risk of this approach is that in ILS the nuances of portfolio implementation matter a lot and can drive big divergences in manager performance.”

The report includes an analysis of 15 ILS managers from 2017 to 2023, all of whom took on roughly similar levels of expected risk. Yet the results were anything but similar. The return gap between the best and worst performing manager each year ranged from 8% to nearly 20%, with a 15% annual average over seven years.

This level of dispersion, they argue, is not the result of reckless risk-taking, but rather stems from structural differences in how portfolios are constructed. Key decisions, such as the balance between remote and non-remote risks, or the choice between catastrophe bonds and private quota share arrangements, can significantly influence outcomes.

Other factors, including whether a manager focuses on reinsurance or retrocession, whether they favour aggregate or per-occurrence contracts, how they diversify and select cedants, and the modelling and risk constraints they apply, can also lead to meaningful performance divergence.

Of course, while these decisions reflect real portfolio design skill, the authors emphasize that catastrophic risk is inherently probabilistic, and even a well-judged position can lead to poor results if bad luck strikes.

“A reinsurer or ILS manager may be skilled in choosing to write a particular risk or counterparty because it was mispriced probabilistically, but if they happen to do so in the year when that low probability event hits that contract, their performance will be hit,” they note. “In other words, while skill matters, luck can dominate skill in this asset class.”

“Our conclusion is that the best way to ameliorate this risk is via a diversified multi-manager strategy. The risk of not doing this, is that you get unlucky with manager selection and—an additional and bigger risk—this coincides with a tough year for the asset class. This likely means heightened stakeholder attention and increases the risk of not being able to participate in ILS when spreads are extremely attractive—as is currently the case,” Abley and Sukhla explain.

The overarching message of the paper is one of long-term positioning and strategic staying power. As they write, “the best way to win in ILS is to stay in the game.”

That staying power starts with diversification, not only across risks and structures, but critically across managers. Doing so reduces the risk of being caught out by manager-specific underperformance tied to unique implementation decisions or bad luck. Portfolio construction, they stress, is far from a commodity; the small details matter, and they compound over time.

Equally important is establishing and communicating a long-term investment thesis. When shared and endorsed by internal stakeholders, it helps investors stay the course during periods of elevated losses and volatility, precisely when discipline is most important.

Finally, the authors make clear that accepting losses is part of the ILS proposition. These are the risks investors are paid to bear. But those losses must be manageable, and ideally, viewed as a buying opportunity when spreads widen in the aftermath of major events.