Sophia Cheng of Cathay Financial says the firm's hedging costs have dropped to 60 basis points
Asian insurers underscored the challenges they face this year as they hunt for yield in the low-rate environment while trying not to compromise on risk, a forum heard.
Asked about relative value of securities in 2015, Sophia Cheng, CIO of Cathay Financial Holdings, said: “If I use one word to describe 2015 it would be volatility. If I use two, it would be uncomfortable volatility. If I have three, super uncomfortable volatility.”
Speaking at AsianInvestor’s Insurance Investment Forum in Hong Kong, Cheng noted that US government bond issuance was 300 times that of Taiwan’s per annum, driving Taiwanese investors offshore.
Cathay Financial now has 46% of its portfolio invested overseas, comprising 41% exposure to the US, 23% to Europe and the remainder to Asia and emerging markets.
In the US its allocation is primarily to corporate credit, debentures and mortgage-backed securities, with almost zero exposure to US treasuries. More generally it focuses on agencies, supranationals and sovereign issuance, while it is also a big buyer of global equity and Greater China equity.
Cheng said Cathay Financial favoured dollar-denominated debt, which it hedges it to avoid foreign exchange risk. It is also focused on the renminbi.
When asked about currency hedging, she observed that 2012 had been a turning point in Taiwan with the introduction of new legislation to allow investment in non-deliverable forwards (NDF). As a consequence she said the firm's hedging costs had dropped from almost 2% in 2011 to 60bp now.
Cheng said the strong dollar had caused emerging market volatility, but that Cathay Financial had started to reduce its EM positions two years ago. Some 75% of its fixed income is rated A1 and above, while it has less than 3% in high-yield bonds.
On the topic of asset-liability matching, Johan Sidik, CIO of Generali Life Insurance Indonesia, told the forum it had become more flexible in its use of tactical asset allocation, fund selection for equities and was generally more active in fixed income. “It means we can take advantage of certain market opportunities during short-term swings,” he said.
Sidik noted that unit-linked products represented 90% of its funds, with just 10% in traditional insurance products. While index-linked products had grown strongly over the past five years, he expects this balance to revert to 50:50 over time.
He said the decline in oil price had little effect on Indonesia, noting that commodity exports were declining in favour of manufactured goods. He noted the weighting of mining and plantation segments on the local stock exchange was less than 10%. “The risk is manageable,” he explained.
The external risk factor he pays most attention to is a pending Fed rate hike, which he is anticipating in June or September. He is basing his projections on forward guidance for the 10-year US Treasury yield of 2.7% in the next 12-14 months. “I am thinking about having a strategy that has less exposure to market beta, but this will be short-term and it is risky,” said Sidik.
Don Guo, CIO of Asia Capital Reinsurance Group, agreed that generating returns had become more challenging. The firm has focused on US investment over the past two years, keeping duration short to meet its liquidity requirements.
While he expects short-term rates to rise, he noted that longer-term rates would not be determined by the Fed but by the central banks of Europe, Japan and even China. He is expecting a rate hike in April or June at the latest.
He suggested currency risk was more difficult to predict. “How we look at risk and return with regard to capital charges is one of the key challenges we face, we are having to find new ways,” he said.
Most of the firm’s fixed income investment is in Asia, although it had a pocket for yield enhancement invested in asset-backed securities and commercial mortgage-backed securities in the US.
While that was junk-rated, Guo noted it had only paid 40-50 cents on the dollar. “We believe the downside is very small but the upside is quite enormous,” he stated.
He said the firm was waiting for the Fed to raise rates. “Then we can position ourselves much better in the market. You can still find value on the emerging market side.”
Tan Soo-Thiam, group head of fixed income investment at AIA, said the firm was focused on matching liabilities on a currency basis, given its diversified bond portfolio across Asia.
But he agreed it was getting more difficult to match liabiligties in local markets, with the exception of Indonesia: “You need to go down into the credit world to get some spread in the portfolio.”
He described the firm as an investment-grade investor, combined with some tactical, bottom-up exposure to high-yield.
He suggested the biggest risk was not liquidity or credit risk, but interest-rate risk. “if it [the low-rate environment] persists, that becomes a major risk. As time goes on, reinvestment risk starts to set in. That can create some issues down the road."
He denied a 25bp rate rise by the Fed in June would be the beginning of a new era. "We think rates will be low for longer," he said, adding the US would be reluctant to hike too aggressively while both Europe and Japan were in quantitative easing mode.