A perfect storm of monetary easing in Asia and Europe, expected US interest rate rises, lower bond yields and stricter solvency rules is playing havoc with insurance companies’ investment portfolios.
The effect of quantitative easing (QE) in supporting equity markets and pushing down yields on bonds has given insurers and other liability-driven investors a major headache. With such a dramatic change in their earnings profile, these investors have been forced to alter their strategies.
To find out just what the impact has been on portfolios, US asset manager BlackRock surveyed 248 global chief investment officers from insurance firms managing a total of $6.5 trillion.
Half of the respondents have already altered their investment strategy in response to QE and monetary policy, while a further 43% intend to make changes over the next 12 to 24 months. Insurers in Asia Pacific see a potential sharp rise in US rates (51%) as the biggest market risk.
David Lomas, global head of BlackRock’s insurance asset management business, told AsianInvestor that insurers in Asia Pacific were shifting focus to income-generating alternative credit assets. He cited as examples commercial real estate debt, direct lending to small and medium-sized enterprises and direct commercial mortgage lending – domains traditionally dominated by banks.
“QE has driven insurers to take on significantly more risk than in previous years,” he noted. And while 73% of those surveyed felt QE was largely positive in being supportive of risk assets, 40% said they were raising their cash holdings. This may appear counter-intuitive, said Lomas, but institutions are looking to create capacity to deploy their cash quickly where opportunities arise.
To take advantage of the limited investment opportunities, funds need to be organised, he added. “Our advice to clients is 'make sure your governance model is working well, so when you have the cash, you can move quickly'.”
However, the reality is that most insurers have not got their act together in this regard. Lomas said, “They are challenged by it, because whether they do it themselves or appoint an external asset manager, they still have to inform themselves [on which markets or managers to pick].”
With the credit cycle turning as high yield seems to have run its course, he said, bond investors are now favouring investment-grade, core fixed income.
But asset managers are offering a range of alternatives. Lomas said that in terms of product “we’ve seen the fastest growth in the infrastructure debt and equity space”.
Private equity and opportunistic credit are also popular, though there is less interest in hedge funds, he said. “The equity beta rally of the last four years has dampened enthusiasm, although that is looking like it may swing back again,” noted Lomas.
Real estate is still of significant interest to large asset owners, especially Chinese institutions, he added. “We are also seeing investment in real estate mezzanine debt, with yields at 10% and high loan-to-value rates.” This is despite growing investor jitters over high property prices, particularly in tier-one cities such as Hong Kong and London.
Meanwhile, product innovation is being hampered by regulatory inflexibility, argued Lomas.
‘We would like to work with regulators to help develop products that match the needs of insurance companies, rather than have a situation where everything is treated as equity. A lot of these new ideas are not equity as you or I know it, so we are asking regulators to recognise that they have different characteristics.”
Stricter capital requirements under the Solvency II rules, which will take effect on January 1, 2016, are pushing insurers globally to hold more investment-grade fixed income and diversify under tighter risk budgets.
“If you don’t get Solvency II right, you won’t attract capital to your business,” said Lomas. “Those with higher solvency ratios can branch out further and invest in higher-returning strategies, which carry higher capital charges.
But for those with lower solvency ratios, this is becoming more difficult due to reduced bond liquidity, in light of dealers’ smaller fixed income inventories and lower bond turnover these days.