The negative art of bond investing

John DeCaro, Elementum Advisors

Elementum Advisors: Best Insurance-Linked Securities Hedge Fund – Elementum Advisors, LLC is an independent investment manager specialising in collateralised natural event reinsurance investments. Headquartered in Chicago, Elementum was launched in December 2009 by Founding Partners and Senior Portfolio Managers, John DeCaro and Tony Rettino, and Managing Partner and Chief Financial Officer, Michael France. Elementum’s firm-wide AUM is USD4.2 billion (as of 30 June 2020). 

This year marks Elementum’s second decade of investing in Insurance Linked Securities (ILS). Referring to the internal culture that has been fostered since inception, DeCaro says the collective goal is to fulfil its vision of becoming the “global ILS partner of choice, delivering superior investment management and an unparalleled client experience”.

“Our investment philosophy is heavily driven by due diligence and the “negative art” of bond investing, with an emphasis on first avoiding loss rather than seeking to initially maximise income,” says DeCaro, 

Elementum expresses its investment views using a variety of ILS-related instruments including: catastrophe bonds, collateralised reinsurance investments, OTC catastrophe derivatives & industry loss warranty contracts, and exchange-traded catastrophe derivatives. 

The team actively manages the portfolio across geographies and types of coverage to capture pricing inefficiencies. With respect to catastrophe bonds, the portfolio held roughly half of the 144A natural catastrophe bonds outstanding as of 30 June 2020. When looking at private collateralised reinsurance investments, the team trains its sights on capacity-constrained reinsurance markets, where pricing is generally more insulated from the overall reinsurance pricing cycle. “We believe the landscape for both ILS and collateralised reinsurance has been, and continues to be, one of the most attractive in the past seven years or so,” states DeCaro. 

He says that when it comes to identifying new opportunities, there is a big emphasis on relative value investing. “Specifically, we are always looking to identify opportunities to add incremental returns by trading the book. This means that we are one of the largest and most active participants in the secondary market for catastrophe bonds.  The pandemic has not had any impact on our investment style in 2020,” explains DeCaro. 

Catastrophe modelling is a cornerstone of Elementum’s investment analysis, portfolio construction and risk management. Its Analytics Team is responsible for developing Elementum’s risk outlook, which is then implemented by the Investment Team dedicated to deal modelling. 

In addition, the team utilises “Blue”, Elementum’s proprietary portfolio and risk management system that utilises real-time portfolio and position level data, including catastrophe risk modelling results, to produce detailed risk and return statistics. 

DeCaro says the team avoids reliance on explicit cat bond financing leverage as a source of incremental return “as we believe there is sufficient risk premium available on a long-only basis to generate acceptable returns for our investors”.  

“That said, we occasionally hold cash and use cash as a source of return while we are waiting for more attractive investment opportunities to arise. We actively hedge the book, primarily through ILW contracts, which are a form of insured industry loss protection on an index basis.” 

ILS strategies provide attractive diversification benefits to institutional portfolios as the embedded event risk is not correlated to other financial asset classes. Nevertheless, ILS are not immune from liquidity-driven sell-offs across asset classes, as was witnessed in March this year. “We typically see institutional investors allocate to ILS from alternative risk premia buckets for catastrophe bonds and from a hedge fund bucket for collateralised reinsurance,” concludes DeCaro. 


John DeCaro
Founding Partner and Senior Portfolio Manager, Elementum Advisors

John DeCaro, CFA, serves as Founding Partner and Senior Portfolio Manager for Elementum Advisors, LLC. John has managed a variety of reinsurance and risk-linked investment strategies since 1997. Prior to Elementum, he co-managed the reinsurance and risk-linked investments team at Stark Investments from September 2005 through November 2009. John earned a BS in Finance from the University of South Carolina, an MS in Financial Markets and Trading from the Illinois Institute of Technology, and received the Chartered Financial Analyst designation in 1997. John also co-authored the Catastrophe Bonds chapter of “Alternative Risk Strategies” (2002).

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