A 2013 study of gross projected IRRs in the life settlements market showed a range of 11 to 18.9 per cent p.a. over periods of differing economic conditions.

“More recently, the Laureola approach to life settlements has averaged double-digit returns over the past eight years. Current research also confirms the lack of correlation between life settlements and other financial markets, especially during periods when traditional markets experience losses,” Mr Lee said

“Such uncorrelated stable returns have attracted notable investors in life settlements such as leading US Endowment and Pension Funds (State of Michigan, Alaska Permanent Fund) and Warren Buffett’s Berkshire Hathaway.

There are two common applications of life settlements in an investment portfolio as a fixed income alternative; and as an uncorrelated safe asset in a portfolio.”

Mr Lee noted today’s fixed income investors face a real dilemma. Traditionally, bonds could be relied upon to provide capital protection with low default risk, returns greater than inflation, noncorrelation with equity markets and the economy, and, most importantly, the ability to sleep at night.

However, bonds and most fixed income instruments might be struggling to live up to their traditional strengths. Interest rates of zero are observed in most of the developed world.

“Current pricing of speculative high yield bonds implies investors might have to accept worse-off conditions, lower rates with higher risk of default. Credit Suisse analysts also reported that bonds might no longer offer diversification from equity risk,” he noted.

“This is potentially where a well-managed life settlements fund can step into the traditional role of bonds. Some policy payouts are protected by the government. The life insurance company must pay out to the policyholder when the policy matures, regardless of the state of the economy or market performance. 

“The US life industry has paid out 100 per cent of all unterminated policies in the last 150 years. A portfolio of life settlement investments can potentially provide meaningful returns in excess of current inflation while not being correlated to traditional markets and economic conditions. All these features combined can enable life settlements investors to sleep well at night.

Furthermore, life settlements’ returns over 3-year periods (a test of consistency) often match that of equities, but with tighter dispersion of monthly returns. 

"The fund’s returns tend to be higher than that of the ASX200 Index and 3-year bank term deposit rates since May 2013," Mr Lee explained.

"This highlights the consistency of performance over a three-year timeframe. Stability can be measured through how widely dispersed the returns of the asset are. The narrow range of returns for a life settlement fund suggests returns volatility closer to that of fixed income when compared to ASX200’s wide dispersion of returns.

Close to zero correlation with other investment markets

Historically, life settlements have close to zero correlation with other investment markets and that might be rare even within the fixed income arena, according to Mr Lee. 

Many investment strategies claim to be non-correlated to equities or other popular investments. However, such strategies can decline along with the general market in a major downturn – the very outcome investors try to avoid,” he said.

“Using the Laureola Investment Fund as the life settlements proxy, life settlements have recorded low levels of correlation with other asset classes. Of note are the low correlations to equities. In addition, the worst 10 months of ASX200 would have caused an average monthly decline of -7 per cent whilst life settlements would have produced an average of +0.9 per cent return."

The life settlements sector, which can be considered a form of financing to individuals secured by that person’s life insurance policy, is one of the very few assets not impacted by equity market movements. The primary reason for this, Mr Lee noted, is that non-correlation might be due to how life settlements transactions are constructed. 

“If one follows the cash flows of a life settlements transaction, one might observe that the usual economic and financial factors such as interest rates, crude oil prices, and equity index levels do not affect life settlement returns,” he explained.

“This fundamental delinking potentially highlights non-correlation in practice, not just in theory. Life settlements have historically provided non-correlation when needed. It is a 'sleep comfortably at night' fixed-income alternative which can potentially generate returns matching equity markets.”