This year, we have witnessed strong hurricanes and earthquakes. The HCP Black fund has invested in five objects which carry the non-cyclical risk of natural disasters. The events that affected HCP Black’s value the most were hurricanes Harvey, Irma, and Maria, and the earthquake in Mexico. The best-performing investment object fell by 2.7% and the worst dropped by 12%. The impact on HCP Black’s value has now been realised as -3.1%. As regards the choice of investment objects, I can be satisfied, as the poorest insurance-linked strategies in the world have already suffered losses greater than 19%, probably relating to less paranoid risk management.
These investments carry the risk of probable natural disasters, typically a year at a time. The pricing of insurances takes into account the fact that nowadays there are more natural disasters than there have been before during the period when comprehensive statistics have been collected. So in the short term, these investments take into account climate change. In the long term, which is over one-year perspective, these investments do not take a stand on climate change, as the contracts are typically less than one year long.
Why own something so risky? Why allocate money to such objects? These investments reduce the total risk in the HCP Black fund. Insurance-linked investments include risks, but only such that are in no way related to the economic cycle. This way, the fund has something that can be sold with profit after a stock market collapse, and stocks, which have the highest return potential of all asset classes, can then be bought at a cheap price.
Insurance-linked securities are alternative investments, and they meet two rare requirements: the gross return, which targets 9% annual return (gross above risk-free interest), is known in advance, and risk is completely independent of financial markets. After natural disasters that have been realised, the annual return has been 5.4% (taking into account the realised natural disasters). Once again I remind you of my latest market review with backgrounds about the current challenges in the stock market (and also the bond market) and the fluctuation between a recession and a boom. In addition to the well-known cycle, the world is witnessing the end of a historically long debt cycle. It makes even a global depression possible. For these reasons, I think that it is highly justified to prepare for difficult times with investments independent of business cycles. It is good to recall that in a recession, the stock exchanges may fall by 50%, and the fall in the global depression of 1929-1932 was as huge as 89%. A global depression is unlikely, but since its effects are so huge when realised, one should also be prepared to it by investing in non-cyclical investment objects.
What also speaks in favour of this strategy is the fact that there is still a shortage of capital in the world that can bear such risk. In wealthy, developed countries, people can afford to buy insurance, but many developing countries are still without protection. In other words, the world is still under-insured with regard to natural disasters, and that’s why investing in them is useful for society (this is so-called impact investing).
Below in the graph, there is one of HCP Black’s investments (in the graph, ILS = insurance-linked securities). This asset manager has over USD 10 billion in insurance-linked investments, and 150 people work for the company. I have chosen this particular company from the many possibilities especially because they have a long history of the insurance-linked strategy, and they are constantly improving the quality of their work. From their current competitors, only 7% were in operation during the 9/11 terrorist attacs, only 17% witnessed the exceptionally severe hurricane season of the year 2005, and only 26% experienced the financial crisis of 2007-2009. It’s exactly survival in these difficult times, such as we are facing now, that is a sign of quality. In addition, more than half of the company is owned by its operational team.
HCP Black’s loss is bitter, but nothing exceptional. The dips in the graph are simply part of the risk that we carry. However, even with the dips, there has been a possibility of good return relative to risk, especially because such investments are economically independent of stock market crises. Regarding another investment item in HCP Black, the graph below presents a model of probability distribution for the net return on a typical investment. This graph also shows that, typically, one can expect net return (in green), but the investment’s risk also includes unlikely but possible losses.
We are in the same boat with you: the entire recession and depression buffer of our company is invested in the HCP Black fund. We hope for the best regarding the world economy and world order, and at the same time we are preparing for other kinds of chains of events. We are no longer alone in this preparedness. Here, you can find another Finn’s writing on the theme ”In just four trading days, the Dow lost 25 % of its value” (you can find a longer version with numbers behind this link). To conclude this update, I will state that investing in insurance-linked securities is at least as justified as before, and I am happy with the quality of the investment objects that I have chosen. The natural disasters now realised have, in fact, increased the demand for insurance and, certainly, also scared off some investors who have been considering bringing their capital to bear this risk. Therefore, more compensation (gross return) is expected from the risk carried, and the realised events will not increase the likelihood of the next natural disaster.
Once more my market view, which is the same that I drew up in March 2016:
They say that those who have been sick for a long time are relieved when they finally get a diagnosis – even if it’s serious. I’ve been bothered by something about the economic situation for four years already. The diagnosis is finally made: the amount of debt and the interest rates that were recently dropped to zero. This is a syndrome. Although the potential consequences may be terrible, I feel some degree of relief.
That blog post is a good start, and you may continue reading post by post towards this day. I will publish updates also in the future when I have something important to bring up.