Global central banks’ concerted moves to cut interest rates in response to the impact of the coronavirus pandemic are likely to hurt institutional investor portfolio returns, especially if regional central banks follow suit.

This is a particular concern for Malaysia’s asset owners, according to Islamic insurer Prudential BSN Takaful.

“Malaysia has experienced a lot of market volatility over the past few months, firstly with the US-China trade tension, and subsequently with the coronavirus,” Anita Menon, the firm’s chief risk officer, told AsianInvestor in an exclusive interview.

Anita Menon
Anita Menon, Pru BSN Takaful

She said that a further rate cut by the Bank Negara Malaysia would likely unsettle local investors and impact the overall portfolio returns. On March 3 the Malaysian central bank cut its interest rate by 25 basis points for the second time this year. The new 2.5% level marks a 10-year low.

“The central bank in Malaysia has already had two overnight policy rate cuts, so this definitely has an impact in terms of the returns [of the takaful] and there has been a bit of a sell down in the market as well,” Menon noted.

The local benchmark, FTSE Bursa Malaysia KLCI Index, has dropped 21.04% year-to-date as of Monday (March 18), comparing to a loss of 21.72% S&P 500 posted on Tuesday’s close (March 17).

The potential for further rate cuts has only increased after the US Federal Reserve conducted a surprise 100bp cut on Sunday (March 15). The increasingly accommodative stance by central banks is a desperate attempt to combat the economic fallout from the Covid-19 outbreak. It has spread across the globe and claimed 7,529 lives thus far, according to an estimate from the World Health Organization on March 17.

Malaysia has reported 673 confirmed coronavirus cases after rounding up 190 new cases following an event at a mosque attended by more than 10,000 people.

Bank Negara Malaysia’s rate cut, in conjunction with the local stock market selloff, is likely to damage the firm’s portfolio, Menon said, declining to specify by how much. The company held nearly 40% of its RM3.1 billion ($720.76 million) investment assets in Islamic debt and a further 41.5% in equities as of June 30 last year.

WHAT CAN BE DONE?

While these risks are likely to hamper potential returns, Menon said maintaining an ample capital adequacy ratio remained her “primary focus”.

Under Malaysia's rules, insurers are required to maintain a CAR of 130%. The company declined to comment on its current level, but it reported RM382.85 million of regulatory capital in June 2019. However, one way to ensure it continues to meet its capital need is to regularly review the firm’s asset allocation, even if it means sacrificing some returns.

Given that cash and government sukuk – shariah compliant bonds – attract lower risk charges, Menon said the insurer could move more of its investments into these defensive assets temporarily, without elaborating. 

Cash and bank deposits with licensed Islamic banks, for example, have a zero risk charge under local rules; this makes them relatively cheap to hold compared to Malaysian stocks, which get slapped with a 20% risk charge.

In addition, Menon added that the liquidity management of the insurer is also key to navigate the volatility, which could entail shifting allocations from small-to-mid cap equities to mid-to-large cap stocks. In doing so, the company may have to suffer in terms of returns, but these investments also offer less volatility.

She declined to comment on whether the insurer could also seek to expand its investments offshore or into alternative assets, as other means of reducing its exposure to market volatility. 

IDENTIFYING EMERGING RISKS

Menon, whose job is to monitor the insurer’s exposure to risks, said it’s important to be alert when global problems such as the coronavirus emerge.

With an established risk identification framework, the firm would track the risks’ developments and trends, consult subject matter experts and “monitor them actively to ensure that we are not caught off-guard or blindsided when these risks actually emerge,” she said.

The firm is no stranger to pandemic risks. In 2012 it had to recognise and respond to the Middle East Respiratory Syndrome (Mers), which was also a type of coronavirus.

“We started recognising that when there was a spike in Mers-related illness, and particularly as takaful [Islamic insurer] company, we do have many of our customers who go for pilgrimage to Saudi Arabia, which is where typically there is a risk of exposure to the Mers virus,” Menon said.

When the coronavirus struck this year, Menon identified it as a risk for both commercial insurance and takaful companies. The industry has since then come together to state that coverage for Covid-19 would be provided under certain conditions. 

Menon declined to comment on what lessons Prudential BSN could apply from the experience of Mers to its business and investment plans today.