AQR Capital Management has formed a reinsurance group that will develop investment strategies that have low correlation with traditional markets and hedge funds.
David G Kabiller (pictured), founding partner of AQR and Head of Client Strategies, is organising this business and has recruited Andrew J Sterge, PhD to lead the reinsurance effort. Dr Sterge, who studied game theory at Cornell, is a top reinsurance specialist and former head of both Pulsar Re Holdings, the reinsurance affiliate of Magnetar, and the Cooper Neff Group.
"AQR now has an experienced reinsurance group," says Kabiller. "It is led by widely recognized industry experts who specialise in portfolio construction and includes expert underwriting and sourcing of these risk premiums."
The AQR reinsurance group will offer dynamic exposures to a set of risk and reward opportunities that are difficult to assemble. These total over 50 different territory and peril exposures with minimal correlations among themselves. The firm expects these exposures will vary substantially from those prevailing in the credit, commodity, equity and currency markets.
AQR conducted an extensive analysis of risk/reward characteristics and the capital requirements and opportunities for reinsurance in general, and soon intends to publish a white paper on its findings. The white paper demonstrates that:
The magnitude of the risk premiums offered in reinsurance resemble those in equities, but unlike equities, there are dozens of reinsurance risks that are independent of one another, increasing the potential for improving the risk/reward characteristics of a portfolio.
A 20-year historical performance review of reinsurance portfolios reveals little significant correlation to global equities, US fixed income, high yield credit, commodities and hedge funds.
Also looking back 20 years, a risk balanced portfolio of reinsurance spread across distinct territories and perils outperforms a "peak peril" portfolio that is concentrated in US hurricane, US earthquake, European windstorm and Japan earthquake.
"Reinsurance is one of the most diversifying sources of risk premium that a pension fund can access, in part because reinsurance risks are diversifying among themselves, unlike the correlation one finds among other financial assets," says Kabiller. "Reinsurance risk allows you to construct a portfolio with very high risk-adjusted returns and limited downside, but with an equity-like risk premium. A diversified portfolio of reinsurance makes for an attractive strategic allocation for pension funds."
AQR’s view of reinsurance conforms to the firm’s general approach to new investment frontiers. AQR undertakes extensive research, often in conjunction with major educational institutions, to analyse and calibrate discrete market inefficiencies that when aggregated, can be successfully exploited through dynamic exposure strategies. AQR’s investment approach strongly emphasises diverse exposure to a broad set of risk opportunities, often in the realm of market inefficiencies created by tendencies unearthed through analysis of behavioural economics.
The reinsurance strategy has a USD250 million funding goal and will be capitalised by AQR and outside investors.
Working with Andrew Sterge will be two veteran, London based reinsurance underwriters, Rick Montgomerie and Charlie Vaughan.