The likelihood of ultra-low interest rates and the Covid-19 pandemic dominating financial markets well into 2021 is leading the both French insurer Axa and Prudential Hong Kong to place increased scrutiny on external partners, particularly as they seek higher returning investment possibilities in alternative assets and high yield debt.
Speaking at the webinar 'Drivers of Change: Macro forces and the New Normal for Insurance', hosted by AsianInvestor in partnership with Columbia Threadneedle on Thursday (November 12), Boris Moutier, Axa's chief investment officer for Hong Kong and Asia, said he has sought to gain more information on the performance of the external fund managers he is working with.
“What we have been trying to do is to look through and in a way also to re-assess our providers, and typically the general partners of alternative investments, how well they managed the crisis. In hindsight, how strong was their analysis before investing. I think that has been key areas of work,” Moutier said.
He noted that this emphasis was increasingly key for active equities, an area in which many fund managers have continued to struggle to outperform. Investing into equity portfolios that fund managers have genuinely constructed with less rate-correlation is not easy.
“It’s sometimes challenging to put together investments which are correlated such as interest rates and values. It is something that we have to do for investment planning for next year,” Moutier said. Lower interest rates typically mean that the present value of a stock is higher if everything else is held constant.
Benjamin Rudd, CIO at Prudential Hong Kong, also spoke on the webinar. He noted that, like many asset owners, he had been stress testing his portfolio to see how it handles a variety of conditions, and to re-assess Prudential’s mainstream and alternative fund manager partners.
“What we did ourselves is just making sure that we understood our portfolio, because honestly the move in spread was largely driven by liquidity … So, what’s really important is understanding the real fundamental credit risks of the underlying portfolio, and not just in the liquid space, but also in the illiquid space,” Rudd said.
“This has become one of the key area of risks which have become more mainstream, as you’ve seen a massive amount of capital moving into alternatives, private debt market, etc."
Rudd added: “What we are trying to make sure is that when we look at those different structures, we’re not just investing in the funds, we’re still making sure that we have that look-through into the underlying exposure of the funds and understanding where the… sector risks, the geographical risks are."
A rising investment theme among most asset owners, including insurers, is to invest more into alternative assets. They are doing so to try and benefit from the illiquidity premium of these assets, which often offer high single digit or double digit returns if asset owners lock their money away for five or more years.
Both Rudd and Moutier said that they see selective opportunities becoming more appealing in areas such as private debt, an asset type that broadly fits with the heavily fixed-income asset focused insurer portfolios.
“[We are interested] when we hear from good GPs (general partners) and big players on alternatives with an intimate knowledge of the corporates to whom they are lending money … maybe they have a few positions but by and large they are often collaterailsed and yields are less depressed as private spreads are a bit more sticky,” Moutier told AsianInvestor immediately after the webinar.
That said, investing into new areas of private debt in particular can be challenging.
“We need to pay GPs and if [we are looking to invest into] new geographical areas we need all the stakeholders to be confirmed [as part of our due diligence],” Moutier said. “ But we expect we will invest more next year.”
The public debt space is more challenging; Prudential’s Rudd noted that investment grade debt has largely become expensive everywhere. For Moutier the answer has been to accept the low returns of investment grade; “we are investing into strong names in investment grade … that are quite safe versus US Treasuries, and also we see Asia high yield as a big thing next year”.
He declined to comment on specific mandate plans, but noted that Asia high yield offers its own challenges, seeing as hard currency high yield bonds are 50% originated from China.
“Headquarters in London and Paris are always cautious about China; they do not take the good news and do take the bad,” Moutier told AsianInvestor. “But we are biased the other way; China’s GDP is positive this year [unlike most countries] and if we choose good fund houses we believe can pick [partners] with strong research capabilities.”
Other areas such as private equity remain highly interesting as well, as well as selective bets on real estate, a sector that has seen a diverse array of reactions to the pandemic. Moutier noted that logistics was a very strongly performing sector of potential interest, but added: “logistics and alternative real estate was getting traction before the crisis and now everyone is obsessed. Korean logistics are a big thing, for example. We will need to rely on experts because there will be overheating. It makes it important to pick good asset managers.”
Finding the money for these investments is one issue that is not a problem. As Rudd told the webinar audience, one advantage of Asia’s life insurers is the fact they are continuing to accrue net inflows, courtesy of growth model businesses in the relatively under-penetrated markets for life insurance. That leaves them cash-rich and needing to find places to invest this money, rather than overly worrying about shifting funds and maintaining liquidity.
Part of the analysis of external partners includes environmental, social and governance (ESG) investing. Life insurers are often not seen as being as proactive as pension funds in the space, but both the insurer CIOs said they have attached a lot of importance to responsible investing when preparing their portfolios.
Rudd noted that Prudential has been very active in the ESG space. "We adopt ESG principles in the entire portfolio construction process...It’s quite a powerful risk mitigator," he said.
External managers who do not meet ESG standards have become an issue for Prudential. The insurer has also been working actively with index providers to create indices to capture lower ESG risks. “It’s going to be an ongoing momentum for the industry", he said, adding that it’s important for asset owners to assume bigger roles in this space.
Axa’s investment policy embeds ESG principles. For example, the French insurer has "fully embedded [ESG] in our credit analysis," and "95% of our bond portfolio is ESG-rated,” said Moutier.