The need of China’s insurers to invest overseas looks set to swell in the coming year, offering international fund managers a vital potential avenue of opportunity.
In August, Ping An, the country’s second-largest insurance group, told its shareholders that it planned to make foreign assets comprise Rmb120 billion ($17.8 billion) or 7% of its portfolio by the end of this year. It then intends to further increase this to up to 10% in the next three to five years.
It marked the first time a Chinese insurer had publicly set out a target for overseas investment. And, in a piece of good news for foreign asset managers, Ping An said it would seek the help of external managers to do so.
Where Ping An treads, others are sure to follow.
“Third party outsourcing in overseas investment is an undoubted trend [for insurers],” Helen Yang, Beijing-based managing director for offshore investment at Bohai Life Insurance, told AsianInvestor.
And it’s a sizeable one. All-told, China’s insurance industry had Rmb14.5 trillion, or $2.14 trillion in assets at the end of August, according to the China Insurance Regulatory Commission (CIRC). That was about 41% of the $5.2 trillion held by the US insurance sector at the end of 2015, according to the Insurance Information Institute. Insurers are allowed to invest up to 15% of this amount, or Rmb2.18 trillion, into overseas assets. To date, however, most have only utilised a fraction of this quota.
That’s set to change as insurers look to invest more outside of China’s borders. They have good reasons for doing so. Last year’s equity crash having shown the vulnerability of the local stock market, onshore bond yields have dropped sharply and credit default risks are rising. Add into this a depreciating renminbi, and it’s no surprise insurers keen to invest overseas.
But unlike sovereign wealth funds and foreign reserves managers, China’s insurance companies’ overseas experience is sharply limited.
“Insurers [in China] are in the early stage of developing their capability and offshore allocations,” Allen Wang, head of Asia institutional business at Standard Life Investments in Hong Kong, told AsianInvestor.
As they eye investing overseas, the insurance companies are taking a leaf out of the book of China’s three state-owned funds, and looking to invest overseas via outsourced mandates.
“We may need to pay some management fees for tuition, asking external managers to help us in [building our] overseas exposure first,” said a Beijing-based investment manager at a small-sized life insurer.
Insurance companies venturing overseas typically do so in four steps.
First, they look for foreign assets in high-quality fixed income space; second, look for risky fixed income assets such as high yield credits to get a higher yield; third, look around everything globally including illiquid assets such as loans and private investments; finally, they move into alternatives such as physical properties or infrastructure.
Leading insurers in Japan, Taiwan and South Korea have progressed in this manner over a period of years. But China’s insurers have registered 20% asset growth annually for the past five years. That’s left them under pressure to invest quickly, especially as the new liabilities of traditional insurers often carry costs of 4% to 5% - and those of more aggressive players can be up to 8% (see the article ‘Explosive Growth’ in the September issue of AsianInvestor). That’s left them with a steep learning curve.
Fixed income is the traditional haven of insurer assets, particularly for life insurers that need long-term stable investments to match their liabilities. Nearly 51% of new general account mandates (both categories of ex-US and specialised fixed income) value in Asia-Pacific region last year.
But there’s a catch: today’s offshore bonds cannot satisfy their return demands. China’s onshore 10-year government bonds offered an annual yield of 2.7% in late October, which is much higher than the negative yields offered by Japanese, German government bonds, or the 1.8% yield offered by equivalent US Treasuries.
Mathilde Sauvé, head of institutional solutions at AXA Investment Managers, noted Taiwanese and Korean insurers are seeking any bonds offering returns higher than 1.5% and 2.5% (net of currency hedge) in overseas, as their onshore 10-year government bonds are yielding at 0.7% and 1.4%.
Both Mirae Asset Life and Taiwan Life have told AsianInvestor they are seeking external managers in fixed income assets, such as US investment grade bonds.
Returns of 2.5% are unlikely to prove sufficiently compelling for China’s insurers, given their elevated return needs. They will likely need post-currency hedged returns of at least 4%. That’s a tough call. Only US high yield offers such levels of return (Bloomberg’s US high yield credit index yielded 6.5% in late October), and Chinese insurers can’t buy overseas junk bonds.
That will likely force the insurers to look towards equities and, increasingly, illiquid alternatives investments.
Look out for part two of AsianInvestor November feature story in the coming days.