The speed and strength of Japan's stock rally this year took many by surprise, not least Asian life insurance firms.

Tactical players – notably hedge funds – benefited, but less nimble investors were caught out, notes Julien Lascar, Asia-Pacific head of distribution for cross-asset solutions at Société Générale.

A long-term underweight to Japan is common among institutional investors, he adds, but “some Hong Kong-based insurers, for example, still have zero exposure to Japanese equities”. That's despite the Nikkei being up over 40% and the Topix 47% year-to-date, as of Tuesday's close.

Life companies take investment decisions on a long-term view, often on a quarterly basis, say market participants. As a result, these firms now face the dilemma of whether they should raise their exposure and, if so, how they should do so, says Lascar.

Some more sophisticated insurers – such as those in Hong Kong, Korea, Singapore and Taiwan – are considering using derivatives to provide downside protection.

“When they want full exposure, they tend to buy straight cash equities,” notes Lascar. But strategies such as enhanced collars – which provide upside exposure and downside protection – have proved popular in Europe and are now being considered increasingly in the case of Japanese stocks and Asian equities generally, he adds.

A collar is a hedging strategy where the purchase of put options – protection against a market downturn – is financed by the sale of call options. An 'enhanced collar' involves buying the most attractive options according to timing of the index roll and volatility levels.

Banks are applying such strategies to fit indices such as the Hang Seng, Kospi and Nikkei. The key is that the market needs to be liquid enough, notes Lascar, so it’s not possible to use them for, say, Malaysian or Thai stocks.

Asset managers are also showing interest in using capital protection in discretionary client mandates, as they don’t want to go “completely risk-on”.

Banks are receiving enquiries from such firms about embedding downside protection in these portfolios. Lascar says there is a pipeline of demand in Asia and he expects to see the first deals done within the next few months.

What investors seem less concerned about these days is tail risk. Last year, hedging portfolios against extreme events was all the rage, with such services much in demand from institutional investors. Typically banks were providing volatility-hedging strategies using the Vix index, which measures S&P 500 volatility.

Investors seem to feel that potential for outlier events to hit portfolios has ebbed this year, says Lascar, although they remain concerned about volatility. Hence SG’s clients are looking more for yield enhancement for their existing strategies than new products as such.