INSTITUTIONAL investors searching for uncorrelated assets could consider a segment of insurance where premiums remain elevated and returns relatively attractive.

That segment is that of insurance-linked securities, which include catastrophe bonds and forms of reinsurance. Such securities provide capital and liquidity to the insurance market.

Nephila Capital product specialist Trevor Jones says premiums over the last few months have been 'very, very high'.

'The asset class is generally uncorrelated to markets, but what is interesting is the level of premiums. The market has been very distressed.

'The insurance market has been severely undercapitalised for a long time, and that was exacerbated in 2008 and 2009.'

In the segment of hurricane industry loss warranties (ILWs), for instance, spreads are at 2006 peaks with little new capital coming into the market. ILWs are options where the strike price is linked to industry-wide claims.

Institutions in Europe, the US and Australia have been drawn to the asset class. It is, however, a relatively unfamiliar one among Asian institutions.

Nephila itself, which is partly owned by Man Group, attracted US$340 million in assets from 11 UK institutions into its catastrophe reinsurance fund in the second half of 2009. It currently manages about US$2.6 billion in assets.

Nephila co-founder Greg Hagood said in a statement on the asset inflow: 'Insurance payouts for damages caused by hurricanes Gustave and Ike and the heavy investment losses and liquidity constraints brought about by the financial crisis have led to a major market shakeout.

'Remaining participants such as Nephila have been able to capitalise on this opportunity and charge higher catastrophe premiums.'

A fund such as Nephila invests in insurance-linked securities covering natural catastrophe risk, including large earthquakes and hurricanes. Such funds earn a yield from premiums, and over a medium to long term, its return profile runs along the lines of three- month US Treasuries plus 6-10 per cent.

Losses occur, however, when catastrophes hit major urban centres such as Houston and Miami. The portfolio typically has little exposure to Asian catastrophe risk as Asia remains relatively underinsured, except for Japan.

Says Mr Jones: 'The asset class behaves like a fixed-income asset until you have an event. You know there will be an event at some point and it will be big. The art is to ensure you have enough yield to pay for the time when you have an event . . .

'Many unsophisticated investors say 'why would I want to invest if I know there is downside risk?' But the argument is that if the event is totally uncorrelated to the rest of your portfolio, then it isn't as much of a concern.'

In short, a catastrophic event is unlikely to occur at a time when stock and bond markets are tanking as well, and there lies the diversification benefit.

Investors, says Mr Jones, should have a mid to long horizon if they are to invest in the asset class.

'The longer the investment horizon, the better the probability of making money. It can happen that you invest on Day One and on Day Two, an event occurs. But you can also be invested and not have an event for five years.

'At this time, your risk- adjusted return is better than at any point historically in the asset class. There is a structural reason to expect to make money, but as the premium is also distorted, it's one of the best times to be in the asset class.'