High-dividend equities, private credit with the right underlying assets, and real assets with strong fundamentals have become potential sources of income in a market heading downwards for Hong Kong-based insurance companies.
That was the message from the stage as AsianInvestor kicked off its Insurance Investment Briefing in Hong Kong on September 30.
Unusual selloff correlation between fixed income and equities as well as regulatory changes coming into play have resulted in insurers having to reassess their allocation strategy.
Equity assets, in particular, may encounter some shifts with the upcoming implementation of the new International Financial Reporting Standard, IFRS 17, from January 2023. While investments in the asset class should still be considered, growth stocks may receive less emphasis due to what might become a bigger regulatory headache.
“For equity investments, IFRS 17 is going to be a really interesting conversation going forward. Having the volatility of the equity going into the profit and losses, all insurance companies are debating and looking into the capacity to classify the equity as long-term to avoid volatility. At the same time, you cannot cut out equity entirely, so equities paying high dividends are starting to make more sense,” Gregoire Picquot, chief financial officer at BNP Paribas Cardif, said on stage.
He indicated that, overall, equities are challenged amid current market uncertainties and on increasing expectations that a recession will be here to stay.
“Equity is still attractive. It is part of the investment universe for long-term investors and it will be our friend long-term although maybe not our best friend right now. I don’t think it’s the right time to move in, from a tactical basis. We have to be a bit patient,” Picquot said.
Courtney Wei, deputy general manager at the investment management department at China Life Insurance (Overseas), agreed that looking at equity with a cash-flow generating approach against growth equity makes more sense right now.
This is especially driven by regulatory changes and risk-based capital requirements where equities will be facing capital charges as with private equity, and yet at the same time face more volatility. They will also not enjoy the same liquidity premiums that are achievable from private equity, she said.
“But another key driving force is the market, and given what we are experiencing in the market, we will hopefully soon hit a point where it is the right time to get into the equity space, and then equity does continue to be our friend long-term,” Wei said.
Instead, she sees real assets among alternative investments as a place with potential in a market where high inflation gnaws away at investment performance. Furthermore, she is focused on assets that are somewhat uncorrelated to financial markets.
“We are looking at strategies within, for example, real estate that are not so dependent on valuation of the properties but instead more dependent on the cashflow stream of these properties. So by researching or investing in that area, we can have certain parts of our portfolio that perform differently from the macro environment,” Wei said.
CAUTIOUS ABOUT LENDING
For Picquot, private credit in the form of direct lending offers potential in the current market. High interest rates mean direct lending is a relatively attractive asset class, although he offers some caveats.
“Direct lending is an option, but I would be very cautious on the nature or the quality of the direct lending you put in your portfolio right now. If we are believing that the recession is going to be a long- or mid-term game, you have to be a bit careful on the underlying assets you are going to select for that,” Picquot said.
He elaborated that investors have to take a view on the target sector from a pure macroeconomic perspective and look at underlying fundamentals, as opposed to simply assessing the asset class itself.
Max Davies, insurance strategist at Wellington Management, said that alternatives are considered to offer a very well-established playbook for investment allocation, potentially providing additional yield for a liquidity premium and incurring no additional capital charges for illiquidity in most cases.
“Alternatives have for some time been one of the antidotes that insurers have used against the low-yield environment. However, now the narrative is shifting more away from alternatives being attractive from a yield perspective and instead from a diversification perspective,” Davies said.
“For instance, in private credit. There has been a lot of talk now about the diversifying properties of private credit. Right now, I would be wary because there is an enormous amount of manager selection risk, and you need a manager with strong sourcing capabilities and experience in the sector. But there is a scope of adjusting covenants to give you some downside protection in private credit,” he elaborated.