nephila - psers presentation revised
TRANSCRIPT
Nephila Capital Ltd
Presentation to PSERS Finance Committee
Harrisburg, PA - June 9, 2011
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Important disclosures
This material is communicated by Nephila Capital Ltd (Nephila) and distributed by Man Investments AG. To the extent that it is distributed in the United
Kingdom, it is communicated by Man Investments Ltd, which is authorised and regulated by the Financial Services Authority. It is intended only for
investment professionals or professional clients and must not be relied upon by any other person.
This material is proprietary information of Nephila and its affiliates and may not be reproduced or otherwise disseminated in whole or in part without prior
written consent from Nephila. Although we have taken every professional care in gathering this information, we do not assume any liability in the case of
incorrectly reported or incomplete information.
This material does not constitute a prospectus, a request/offer, nor a recommendation/solicitation of any kind, e.g. to buy/subscribe or sell/redeem the
described investment instruments or to perform other transactions of any kind. This document and all information contained herein is not intended for
persons and/or organisations subject to U.S. federal, state or local law, or to any jurisdiction or legal provisions prohibiting the subscription/buying or
redemption/selling of any shares/units of the described investment product whether on the basis of domicile, nationality or for any other reasons.
Please be aware that investment funds involve investment risks, including the possible loss of the principal amount invested. Please see the relevant
Offering Memorandum for a detailed description of the risks in relation to each share/unit of the investment fund. Man Investments,
Nephila and/or any of their affiliates may have an investment in the described investment products.
There is no guarantee of trading performance and past performance is no indication of current or future performance/results.
www.nephilacapital.com
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Executive summary
The investment manager
Asset class overview
Investment opportunity in 2011
Portfolio and performance overview
Appendix
The investment opportunity Access an attractive asset class through a leading manager
Experience
• Nephila Capital is the oldest dedicated manager in the insurance linked securities (ILS) sector
– launched its first fund in 1998
– AUM of ~ $4 billion1
– SEC registered since 2004
– 32 people, based in Bermuda
– 100% employee participation in the Company equity and/or funds that Nephila manage
Investors
• Institutional platform
• Approximately 73% of Nephila‟s current investors are pension funds
Zero beta asset class
• ILS are generally not correlated with financial markets
• Portfolio benefits of the asset class are broadly accepted by investors and consultants
Source: Nephila Capital Ltd. 1. As of April 1, 2011. 2. Employees are either invested in the funds or management company. 3. Investhedge. Watson Wyatt: Towers Watson Defends Asset Diversity article can
be located at http://www.towerswatson.com/press/1738. Mercer: Mercer predicts top ten investment trends for 2010 article can be located at
http://www.mercer.com.au/summary.htm?siteLanguage=1012&idContent=1368600. This reprinted article should not be construed as an offer to sell or a solicitation of an offer to buy securities or any
product mentioned in this article. All data in the article was provided by Towers Watson and Mercer and has not been independently verified by Man Investments Inc.
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• ILS returns are generated by
charging an insurance premium for
taking the risk of an extremely
large catastrophe (e.g. hurricane
Katrina)
• Primary diversification created
among geographic regions (USA,
Japan)
• Secondary diversification is
obtained within a geographic
region (US hurricane exposure
spread among Florida, Texas &
New York)
Peak geographic areas for catastrophe reinsurance
Earthquake
California
USA Hurricane
Earthquake
New Madrid, USA
Winterstorm
Europe
Earthquake
Japan
Typhoon
Japan
Source: Swiss Re Capital Markets and Nephila Capital Ltd. database. As of March 31, 2010. Figures represent potential losses by geographic/peril exposure in $ billions. 1. Earthquake Japan does
not include claims that would be paid by Japan Earthquake Reinsurance Co. There can be no assurance that Nephila‟s strategy will generate profits.
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2D Graph 1
Peril
US hurricane
US earthquake
Japan earthquake
Japan Typhoon
European windstormAustralia
AviationSatellite
Loss
( $
bill
ions
)
$0
$50
$100
$150
$200
$180B
$90B
$52B
$42B$32B
$24B
$3B $1B
• Largest need for capital is for US
exposures
• Reinsurance industry generally
undercapitalized for peak US
exposures, over-capitalized in
other regions
• Reinsurance companies over-
diversify due to rating agency
constraints
• Spreads compress as need for
capital diminishes
• Smaller classes of insurance risk
offer limited opportunity for
positive expected return over time
Need for Capital in USA Reinsurers Over-Diversify
Source: Swiss Re Capital Markets and Nephila Capital Ltd. database. As of March 31, 2010. Figures represent potential losses by geographic/peril exposure in $ billions. 1. Earthquake Japan does not include
claims that would be paid by Japan Earthquake Reinsurance Co. There can be no assurance that Nephila‟s strategy will generate profits.
Approximate insured loss from 0.40% expected loss by region/peril
Peril US
hurricane
US
earthquake
Japan
earthquake
Japan
Typhoon
European
Wind Australia Aviation Satellite Terrorism
Risk 0.40% 0.40% 0.40% 0.40% 0.40% 0.40% 0.40% 0.40% 0.40%
Premium 6% 4.5% 3.5% 3.25% 3% 2% 1.5% 1% 1%
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Uncorrelated returns and diversification Strong relative performance during crisis periods
Source: Nephila Capital Ltd database and Bloomberg. There is no guarantee of trading performance and past performance is no indication of current or future performance/results. The periods selected are
exceptional and therefore do not reflect typical performance. The dates chosen were based upon research and assessment, as explicit start and end dates for these events were not available. To a certain extent,
the start and end dates of such events are subjective as different sources may suggest different date ranges, leading to different performance figures. 1Nephila is represented by Nephila Catastrophe Fund Ltd net
of all fees and expenses from April 1, 1998. World stocks: MSCI World Index hedged to USD (price return). World bonds: Citigroup World Government Bond Index hedged to USD (total return). Hedge funds:
HFRI Fund of Funds Composite Index. Please note that the HFRI index data over the past 4 months may be subject to change. Commodities: S&P GSCI Commodity (total return) Index.
*Please note that the product performance for December 2010 is estimated.
Event Total return period Nephila1 World
stocks
World
bonds
Hedge
funds Commodities
Financial crisis 1 July 2007 to 28 February 2009 14.6 % -51.0 % 13.7 % -19.3 % -43.1 %
NASDAQ crisis/bear market 1 April 2000 to 31 March 2003 28.3 % -47.8 % 25.3 % 2.1 % 25.0 %
World Trade Center crisis 1 September 2001 to 31 December 2002 11.8 % -25.9 % 9.1 % 1.8 % 4.3 %
Russian crisis and LTCM crash 1 August 1998 to 30 September 1998 0.7 % -14.2 % 4.7 % -9.8 % 3.7 %
Correlation to Nephila1
April 1, 1998 to April 30, 2011*
World
stocks
World
bonds Hedge funds Commodities
Nephila¹ -0.01 0.09 -0.08 -0.05
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Executive summary
The investment manager
Asset class overview
Investment opportunity in 2011
Portfolio and performance overview
Appendix
Organization Structure
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Why are we based in Bermuda?
• The center of expertise for catastrophe reinsurance
– Largest property catastrophe reinsurance market
– Bermuda supplies 67% of the Florida reinsurance capacity1
• Market controlled by over the counter insurance brokers (AON, Marsh & McLennan, Willis)
– Relationships critical, OTC reinsurance market information flow vital
– Established physical presence in Bermuda (10 years)
• Bermuda domicile provides no tax benefits to the firm or its investors
• Barriers to entry high for competing fund managers
– Cannot write OTC reinsurance from U.S. or London because of tax/regulatory risks
Source: 1International Business Information Report #15, April 2008.
Being in Bermuda is a competitive advantage in an opaque, OTC broker driven market
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Executive summary
The investment manager
Asset class overview
Investment opportunity in 2011
Portfolio and performance overview
Appendix
12
• Since the mid 1850s, catastrophe risk has been transferred from insurance companies
to reinsurance companies
• In 1994, catastrophe risk also began to be packaged into securities
A developing asset class Market evolution 1800s to current date
Capital markets
1800s to 1993
Schematic illustration. Source: Nephila Capital Ltd. Database.
Insurers
(Allstate, Royal Sun Alliance,
Tokio Marine, QBE)
Swiss Re, Munich Re,
Berkshire Hathaway
1994 to present
Bonds and options
Catastrophe
risk
Insurers (Allstate, Royal Sun Alliance, Tokio Marine, QBE)
Catastrophe
risk
Reinsurers
Swiss Re, Munich Re, Berkshire Hathaway
Reinsurers
• Cat risk packaged into bonds, rated securities, sold directly to pensions, etc.
• Cat bond market is growing but represents only 8% of annual notional cat risk traded
• Access to other market segments crucial for optimal portfolio construction
Source: 1Swiss Re Capital Markets. As of March 31, 2011. Any descriptions or information involving investment process or strategies is provided for illustration purposes only, may not be fully indicative of any present or
future investments, may be changed at the discretion of the investment manager and are not intended to reflect performance.
Catastrophe bond issuance1 Natural catastrophe bonds only
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
$ in
mill
ions
0
2000
4000
6000
8000
$ in
mill
ions
0
2000
4000
6000
8000
10000
12000Issued
Outstanding
714 742 8251,125
967 990
2,388
1,143
2,500
5,696
8,462
2,980
3,480
5,025
1,015
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Overview of instruments traded
Instrument Annual Notional
Traded Duration Barriers to entry
Catastrophe Bonds $4 B 2-3 years Very low – Goldman Sachs, Merrill Lynch
ILW (Industry Loss Warranties) $6 B 6-12 months More difficult than bonds, but easiest of OTC instruments
These trade as
reinsurance
contracts, not
securities. Need
a reinsurance
company to
transact.
Traditional reinsurance $150 B 12 months High barriers: must have broad sourcing resource, significant
analytical capabilities
Retro $5 B 12 months More difficult than ILWs, much easier than traditional reinsurance
Private transactions $10-$20 B 12-24 months Very high barriers, need significant size and superior
creditworthiness to participate (Berkshire, collateralized)
Quota Share or “ILS Portfolios” n/a 12-24 months Low barriers, as simply paying a reinsurer to access their platform
~ $200B of catastrophe exposure trades each year, broken down as:
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Texas Portfolio Benefits of Traditional Reinsurance Contracts
Company 2 Company 6
Company 7
Company 3 Company 4
Company 1
Company 5
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• Nephila rotates opportunistically among the most attractive market segments
Portfolio composition Responding to changing market dynamics
Source: Nephila Capital Ltd database. ¹As of October 1, 2010. The sector allocations are designed to reflect the expected long-term risk exposure to each sector relative to the other sectors in the portfolio. The
percentages are based on estimates of the risk of each sector for the current portfolio. The portfolio structure and constituents are regularly reviewed by the investment management team and sector allocations
will change accordingly. There are risks inherent in futures trading programs. ²Represents 1% net short position. Any descriptions or information involving investment process or strategies is provided for
illustration purposes only, may not be fully indicative of any present or future investments, may be changed at the discretion of the investment manager and are not intended to reflect performance.
Historical net sector exposure (Nephila Fund Ltd)1
Industry loss warranties
Catastrophe bonds
Reinsurance
Retrocession
Relative value and arbitrage opportunities
2005 2006 2007 2008 2009 2010
Cat bonds
ILWs
Reinsurance
Retro
Attractively priced segment of the market
Fairly priced segment of the market
Poorly priced segment of the market
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Country weighted industry loss (CWIL)
2005 2006 2007 2008 2009 2010
-40 %
-20 %
0 %
20 %
40 %
60 %
80 %
100 %
120 %
140 %
9%
13%
45%
33%
54%
12%
23%
11%
74%
10%
17%
39%
9%
45%
-1%4%
45%
4%
47%
-28%
6%
61%
22%
7%
39%
2
• Nephila collateralizes most of its reinsurance transactions
• All positions have limited liability
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Access across capital structure Value proposition: less competition at the top
Typical reinsurance program
Cre
dit r
isk
Selective layers (5-10 major players)
• Larger credit risk concern for „super-catastrophes‟ reduces the
number of acceptable counterparties
• Insurers are willing to pay more for fully collateralized coverage
so these layers offer better value and less cyclical pricing
Nephila is a preferred counterparty and market leader in
offering collateralized coverage due to their ability to offer
deals of significant size
Private layer 2% default probability, pays ~ L+10%
Private layer 2% default probability, pays ~ L+10% USD 60 bn
Top layer ~5% default probability, pays ~ L+16%
USD 40 bn
(Katrina)
Middle layer 10% default probability, pays ~ L+22%
USD 25 bn
Bottom layer 20% default probability, pays ~ L+32.5%
USD 10 bn
(Ike)
Ind
ustr
y loss
Le
ss c
om
petitio
n
Mo
re c
om
pe
tition
Retention/deductible
Competitive layers: (30-40 reinsurers)
• Most traditional reinsurers and hedge funds are overweight
bottom and middle layers to generate ROEs consistent with
their cost of capital/target returns
• Pricing is generally less attractive and more cyclical because
there are more participants
Source: Nephila Capital Ltd database. Any descriptions or information involving investment process or strategies is provided for illustration purposes only, may not be fully indicative of any present or future
investments, may be changed at the discretion of the investment manager and are not intended to reflect performance.
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Executive summary
The investment manager
Asset class overview
Investment opportunity in 2011
Portfolio and performance overview
Appendix
Current Market Conditions Spread widening post Japan
• Series of mid-sized losses impacting reinsurers and causing spike in “non-peak” or “cold spot”
earthquake pricing: (Chile earthquake, two New Zealand earthquakes and Australian floods)
• Japan earthquake changing structure and pricing in the market
• Changes in US hurricane catastrophe models will increase demand for reinsurance at June 1
• Net result:
- spreads for “non-peak” earthquake coverage have widened 2-3x
- spreads for Japan earthquake have widened 2-3x
- spreads for US earthquake ILWs have widened 25-35%
- spreads for US hurricane ILWs are quoted 20-30% wider
• Nephila provided ~ $500m of liquidity to distressed counterparties immediately after the Japan quake
- opportunities in retro and ILW markets, generally at higher expected losses
- distressed trades allocated to Palmetto, Juniper & Triton Catastrophe Funds
• Cold spots and Japan situation providing opportunity for broader portfolio diversification without
sacrificing expected return and without adding materially to the tails of the distribution 19
Non-Peak Earthquake Pricing Development
0
5
10
15
20
25
30
Pre Chile Post Chile Post New
Zealand 1
Post New
Zealand 2
RO
L (
%)
$3bn ILW
$5bn ILW
Post
Australia
Entered market
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Sample Trades post Japan Quake
Region Strike price Pre-Event price Post-Event price
Japan Quake
USD 10 B 4.75 % 15 %
Japan Quake USD 25 B 3 % 8 %
Japan Quake USD 50 B n/a 5 %
USA Quake USD 20 B 7.25% 10.5%
USA Quake USD 30 B 5% 7.75%
(0.40% expected loss)
Cold spots and Japan situation providing opportunity for broader portfolio
diversification, without sacrificing expected return.
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Executive summary
The investment manager
Asset class overview
Investment opportunity in 2011
Portfolio and performance overview
Appendix
• Target net return of 8%-10% over time, expect ~10%-12.5% over next 12 months
• Very diversified, high position count – 182 total positions
• Expected loss per position: 2-3%
• Relative value focused, averaged ~ 2.50% RV profits per yr over last 5 years
• Maximum risk capital of 25% of equity at 99% confidence level
• Well positioned to take advantage of current spread-widening for both US and worldwide exposures
• Position level risk reports (monthly) and investment letters (quarterly) provided to all investors
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Palmetto Fund Ltd overview
Palmetto Fund Ltd portfolio
Objective Geographically diversified portfolio of remote catastrophe risk (low expected loss, high industry loss)
Inception January 2001
Return objectives 8-10% over 3-month US T
Assets under management1 $387 million
Number of positions 182
Source: Nephila Capital Ltd. database. 1. As of April 30, 2011. *The Total Notional Exposure (% of NAV) may not sum to 100% as exposure can be double counted by geography and/or peril. **The Long and
Hedge are expressed as a percentage of the overall absolute value of notional outstanding. The Net takes into account the netting effect of the offsetting hedges in each category and is expressed as a % of net
notional.Portfolio allocations are selected by, and will vary at the sole discretion of, the Fund‟s investment manager and are subject to availability and market conditions, among other things.
Total Notional Exposure (% of NAV)*
As of April 30, 2011
Exposure by Instrument (% of Notional)**
As of April 30, 2011
US Northeast W
ind
US Southeast Wind
California Earth
quake
US Earthquake (e
x-California)
European Wind & Flood
Japan Wind
Japan Earthquake
Australia/New Zealand All P
erils
2nd Event US All P
erils
2nd Event ex US All P
erils
% o
f N
AV
0%
10%
20%
30%
40%
50%
Reinsurance
ILW
CatBonds
Retro
Long Hedge Net
16%
24%
28%
14%
18%
100%
19%
32%
15%
20%
14%
CWIL
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Executive summary
The investment manager
Asset class
Investment opportunity
Portfolio and performance overview
Appendix: additional information
26
Pension Funds
73%
Manager
1%
Insurance
Companies
3%
Endowments
3%
Family Office /
Hedge Fund
5%
Fund of Funds
15%
Institutional investor base
Strong representation of pension fund capital worldwide
Existing pension fund investors have increased their capital commitments in
light of recent spread widening
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Private Transactions
Much of the reinsurance market transacts on a syndicated basis, but there is a large, attractive private
transaction market that exists for certain market participants (well-rated, large firms)
• Berkshire Hathaway has dominated the private transaction market historically because:
– they can execute large notional transactions
– they have a very strong credit rating (AA+)
• Private transactions provide multiple benefits:
– pricing power over a counterparty: either better absolute returns or better risk-adjusted returns
– transactions are core to the insurer and therefore less impacted by cyclicality in pricing
– often provide portfolio diversification benefits otherwise not available in the market (state pools)
– increases deal flow and lends itself to a more strategic relationship with brokers & counterparties
• As Nephila has grown AUM, it has been invited to this private transaction market because:
– we can execute large notional transactions
– we provide very strong credit rating (either 100% collateralized with US t-bills or AA paper)
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Benefits of Scale „Private transactions‟ 2006 - present
• Nephila has transacted 65 deals of $40M or larger since 2006
• 20 of these transactions have been for $75M or greater
• These 65 deals represent over $4B of notional traded
• These transactions are effectively private cat bonds
• All of the trades provided one of the previously mentioned benefits for the portfolios
SIZE (USD) NUMBER TOTAL (USD)
Greater than 150M 3 533M
100M to 150M 8 857M
75M to 100M 9 758M
50M to 75M 29 1,585M
40M to 50M 16 680M
2%
5%
9%
19%
19%
22%
6%
18%
Counterparty Type
Australian Insurer
BDA Insurer
EU Insurer
EU Reinsurer
FL Insurer
Lloyds Syndicate
State Pool
US Insurer
Please refer to Nephila paper “Benefits of Scale” for fuller discussion and
case studies
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North Carolina Portfolio Benefits of Traditional Reinsurance Contracts
Company 2
Company 4
Company 6
Company 7
Company 3
Company 1
Company 5
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Frank Majors, CFA
Mr. Majors is a Principal and co-founder of Nephila. Since 1997 Mr. Majors‟ primary role has been as portfolio manager of the funds managed by Nephila. He formulates investment strategy and oversees risk management. Mr. Majors has been active in the reinsurance markets in New York, London and Bermuda during his career. He began his career as a reinsurance broker in New York in June 1991, with Willcox, Inc. (now part of Guy Carpenter). In 1993 he joined Willis in New York, transferring to Willis London in 1995 and then Bermuda in 1999. Mr. Majors attended Vanderbilt University on a National Merit Scholarship, receiving his B.A. in Economics in 1990 and an M.B.A. in Finance from the Owen Graduate School of Management at Vanderbilt University in 1991. Mr. Majors also is a holder of the CFA designation.
Greg Hagood
Mr. Hagood is a Principal and co-founder of Nephila. Since 1997 Mr. Hagood‟s primary responsibility has been as portfolio manager, along with Mr. Majors, of the funds managed by Nephila. He coordinates all discussions with capital providers, strategic relationships and oversees operations management. Mr. Hagood began his career with AT&T, and in December 1993 joined Bear, Stearns & Co. in New York where he managed the mortgage servicing trading desk. Mr. Hagood was responsible for trading and brokering mortgage servicing portfolios, advising on mortgage banking mergers and acquisitions and structuring hedging instruments for institutional clients. Mr. Hagood left Bear, Stearns & Co. in February 1997 to join Willis Group Ltd. in London, specifically to start what is now Nephila Capital. Mr. Hagood was a licensed broker at Lloyds of London and received his B.S. in Finance from the University of Tennessee in 1990.
Barney Schauble
Mr. Schauble joined Nephila in 2004 as a Principal. Mr. Schauble‟s primary responsibilities include investor relations, risk sourcing, and other business development projects, as well as portfolio management. Mr. Schauble began his career in New York in 1994 as a broker for Marsh, and later moved to Guy Carpenter (Marsh‟s reinsurance broking subsidiary). Mr. Schauble left Guy Carpenter in 1996 to join Goldman, Sachs & Co as part of their new Risk Markets effort, which was focused on securitising insurance risks and other areas of intersection between insurance and capital markets. He was transferred to London in 1999, where he co-headed the European effort, before returning to New York in 2002. His responsibilities as a Vice President in Risk Markets included client coverage, product development, syndication and distribution for a variety of structured products such as risk-linked securities, weather derivatives, and credit derivatives. Mr. Schauble joined XL Capital‟s Weather & Energy subsidiary in 2003, and was appointed head of marketing for the weather business. At XLWE he was responsible for managing a global team, originating weather risk management business and hedging XLWE‟s excess weather risk with insurance and capital markets counterparties. Mr. Schauble attended Harvard College and received his B.A. in Economics in 1994; he wrote his senior thesis to explore the concept of investing in bonds linked to property catastrophe reinsurance risk.
Steve Glassman
Mr. Glassman joined Nephila in 2010 as a Managing Principal and Chief Management Officer. He will be involved in all aspects of Nephila's business, with a focus on strategy, structured products and the management of human resources and business processes.Mr. Glassman joined Nephila after spending over 22 years with Merrill Lynch/Bank of America in New York, working in the real estate group, primarily in the commercial real estate space. Steve was most recently the COO of the Global Real Estate Principal Investments (GREPI) group; working with all infrastructure and support partners to ensure proper controls, infrastructure and management was in place to support the global real estate platform. In addition, up until March 2009, Mr. Glassman was the head of Asset Management (Americas) for GREPI for approximately ten years. Prior to these responsibilities, he managed the Structuring and Transaction Management group for GREPI (Americas) structuring and executing senior debt, mezzanine debt, bridge equity and equity investments. He has structured transactions and managed assets in the US, Europe, Asia, Mexico and Canada. Prior to joining GREPI, he managed a team of Merrill Lynch professionals in advising clients in the disposition of sub- and non-performing residential loans and real estate. Mr. Glassman was a co-founder of Bayhead Advisors, LLC, which was formed in 1995 to invest in CBOT PCS Catastrophe Options. Mr. Glassman received his BA in Economics from Vanderbilt University.
Key professionals
Additional biographies are available at www.nephilacapital.com