European life insurers’ investment teams are having to navigate a welter of concerns – from unprecedented geopolitical risks (trade war and Brexit anyone?) to macro issues such as a looming US recession, along with sky-high asset prices.
And they are doing so while enduring regulatory constraints and long-term policy guarantees set during times when returns were substantially higher.
One of their most popular responses has been to pour into private markets, most notably into unlisted credit. The asset class works well for insurers; it can help match liabilities, provides a stable income and can help enhance yields. Buying private debt has accelerated even as the so-called ‘illiquidity premium’ from such assets has narrowed.
Of course, this investment approach offers its own risks. Predictions of a global economic downturn are widespread, raising concerns that liquidity risk across public and private markets could spark a credit crunch.
Such issues should also be on the radar of Asian insurers.
They have also been increasingly buying into private credit and other illiquid asset classes, even as Asian jurisdictions are increasingly shift towards similar regulatory frameworks to that of Europe.
Eventually, Asia’s insurers could soon find themselves facing very similar problems to those being tackled by Europe’s insurers.
LIQUIDITY SHOCK FEARS
The question of debt liquidity is particularly critical for European insurance firms. Some allocate over 90% of their assets to the asset class. Proponents of private markets argue that ultra-low yields on bonds mean insurers have no choice but to move into riskier or less-liquid asset classes in search of higher returns.
Bond markets are also less liquid than before the 2008 global financial crisis, because banks no longer hold big fixed income inventories.
Instead, insurers and other long-term investors have stepped into the financing breach left by dealers. Private debt has become increasingly popular in recent years.
It offers relatively long durations, matching potential and has relatively low risk-capital charges under Europe’s Solvency II directive, which stipulates how much capital insurers have to hold against particular types of assets.
Indeed, UK life insurers are believed to have around 40% of their annuity business portfolios in private credit, and they want to raise this to 50%.
London-based Phoenix Group holds 20% of its £15 billion ($18.9 billion) annuities book in private debt but wants to double this to 40% in five years, said Daniel Blamont, head of investment strategy.
The firm, which has £240 billion under administration across Phoenix and Standard Life (Phoenix having acquired the latter’s business this year), started investing in private assets only in 2014.
Asian insurance firms are well behind their European peers in allocating to private credit. The latter average an 8% to 10% allocation versus perhaps 3% to 5% in Asia, according to Alexandre Mincier, Paris-based global head of insurance at US fund house Invesco.
But the Asian players are looking to build exposure.
“We’re seeing more and more first-stage interest in more illiquid investment from insurers in Asia,” confirmed Estelle Castres, global head of key insurance clients at Natixis Investment Managers. They have a clear focus on European real assets, in areas such as infrastructure and renewable energy, she said.
AIA, a leading Hong Kong-based group, began eyeing its first investments into infrastructure loans in 2018, while Zurich’s Malaysia unit plans to enter the private debt market in 2019.
This popularity has inevitably caused private debt yields to tighten. Indeed, some industry experts argue that private credit yields are now little higher than those of traditional bonds.
Eurozone infrastructure debt and senior real estate loans are yielding just 1.5% to 2%, down from 4% to 4.5% in 2012, said Invesco’s Mincier.
As a result, “the yield enhancement you are getting for illiquid assets is nowhere near what it needs to be”, Con Keating, chief executive of UK independent consultancy BrightonRock, who advises on pensions, insurance and capital markets, told AsianInvestor. He did not elaborate on what he felt the minimum yield enhancement should be.
Nonetheless, insurers still want to take private market risk, but they recognise they need to be more selective.
“There are still some deals worth doing, but it’s about making sure you are among the first people that the banks or brokers call,” said Blamont of Phoenix Group. “Even private deals can end up being syndicated across 10 or 20 insurers, meaning you will be getting into price competition and not be able to dictate the terms of the debt.
“You need to have scale to be able to take a whole deal or be one of two or three parties, at most,” he added.
Mohamed El-Erian, chief economic adviser at German insurer Allianz and former chief executive officer of bond fund giant Pimco, has mooted the prospect of a major liquidity shock. With slowing global growth, the China-US trade disputes and the removal of central bank stimulus, “we are transitioning from relative certainty to uncertainty”, he told a press briefing in early December.
“For me, the biggest source of a market accident, which people don’t appreciate enough, is that the marketplace has over-promised liquidity,” El-Erian said during a trip to Hong Kong.
A particular concern for the fixed income veteran is the rise of exchange-traded funds on segments of illiquid high yield and illiquid emerging market corporates.
This story is adapted from a longer feature in the December 2018/January 2019 edition of AsianInvestor magazine.