Growing uncertainty is pushing more asset owners to diversify their investments into new asset classes. But venturing into unfamiliar territory isn't a straightforward decision.
While some have looked to build out their in-house talent, others have enlisted outside help.
In Asia, outsourced institutional investor assets under management total some $11 trillion and are expected to rise by a further $1.2 trillion by 2023, according to a McKinsey report in October.
The real estate asset class, in particular, has attracted interest; some 70% of institutions have outsourced their entire real estate portfolios to third-party managers, a recent annual survey by Hodes Weill & Associates and Cornell University’s Baker Program in Real Estate also shows.
According to the survey, only 4% of investors manage their entire real estate investments internally.
Larry Wan, the former chief investment officer of AIA China, has called on smaller Chinese insurers to outsource more to external managers due to the limitations of their in-house teams.
That said, several insurer CIOs in Asia have questioned the merits of handing out assets to third-party managers who might not necessarily generate enough of an extra return for investors.
So questions remain over the extent to which asset owners should outsource their allocations to external managers and whether now is a good time to do so.
AsianInvestor asked an insurance industry expert, investment specialist and a wealth business head for their views on the topic.
The following extracts have been edited for brevity and clarity.
Iain Forrester, head of insurance investment strategy
We see two broad strategies adopted by asset owners in Asia: smaller insurers are outsourcing all assets under management, while larger players are looking to outsource asset classes where appropriate. This typically involves assets such as alternatives – an asset class where they have no prior expertise – or a geography where they don’t want to build a specific investment capability and will, therefore, look to use an external manager.
What we are seeing now is that core fixed income allocations remain the dominant investment. But there has been growing interest in private credit, with insurers considering multi-asset credit mandates relative to single-strategy credit. This gives managers the ability to move between assets according to where the best opportunities are, whether in public markets, such as emerging markets debt, or private markets, such as real estate and infrastructure debt.
Given the historically low level of interest rates and the evolving regulatory environment that asset owners are operating in, we expect the trend of asset outsourcing among Asian insurers to continue.
Reducing levels of yield have encouraged insurers to extend their investments into a broader range of diversified asset classes and geographies in order to both meet their target returns and manage their regulatory capital positions. As they do this, there will be greater need to access third-party investment expertise.
When making that decision, insurers will typically want to partner with asset managers that have a deep understanding of insurance asset management, insight into the local regulatory environment, and can provide the transparency [that] insurers need. The focus on transparency is broader than just providing high-quality asset data reporting – it’s also having access to the investment process, for example, providing clients with internal credit assessments of private credit assets.
Jayne Bok, head of investments for Asia
Willis Towers Watson
Outsourcing is not new as most asset owners have been outsourcing the tasks of identifying, evaluating and negotiating with external asset managers, since researching and selecting managers is a time- and resource-intensive activity. Asset owners generally outsource conventional asset classes such as listed equities and bonds to external providers.
Some larger Asian asset owners have outsourcing arrangements for investing in alternative assets, particularly hedge funds, private equities and infrastructure. Building an in-house team that can run a competitively successful alternatives programme is an expensive exercise that requires a high level of stakeholder support and buy-in. The choice of asset classes and the level of complexity for outsourcing should be aligned with the resources employed, especially time and related expertise.
There is no good or bad timing for outsourcing. It comes down to knowing yourself, your capabilities, and your ambitions, and adjusting your model to be consistent with those factors. Deciding whether to outsource an activity depends on the following factors rather than timing or market volatility.
Asset owners wish to outsource because (1) they don’t have the scale to develop internal resources, or (2) because investment activity is a distraction from their core business, or (3) they recognise that they are not able to build the core competencies required to manage investments.
One of the reasons the outsourced chief investment officer (OCIO) model has gained traction in pension markets lately is actually due to the experience that funds have of insourcing and the challenges they’ve faced as a result.
One final but important consideration is cost. If the cost of outsourcing exceeds that of insourcing by a sufficient degree, then insourcing may be more to a fund’s advantage. This is one of the reasons that large, sophisticated investors with large assets under management are more inclined to insource.
However, for investors who lack this scale, the cost efficiencies that an OCIO provider can achieve through scale and better fee arrangements is usually significantly higher than what an individual investor can achieve. The OCIO model gives asset owners access to a much broader opportunity set, which enables them to build more resilient and robust portfolios. This will be important given the uncertain market outlook.
Adeline Tan, wealth business leader for Hong Kong
Asset owners outsource all forms of asset classes to third parties – most commonly directly to asset managers and, increasingly, to multi-manager solution providers.
Asset owners have been outsourcing asset management activities owing to a lack of in-house operations/expertise to deal directly in securities, stay diversified and manage the portfolio’s risks, and produce ongoing reporting. I've had clients who have held some direct Hong Kong equities, cash deposits and short-term Hong Kong and US government bonds, but will outsource over 90% of their portfolio to third parties. This way, they can benefit from the scale and expertise of a manager.
Even for index-tracking any asset owner will be challenged to purchase every security in an index and regularly rebalance to be in line with the index.
There are also benefits from a governance perspective as the providers have a broader view of the world and have resources to examine risks closely. The environmental, social and governance (ESG) aspect is another element, whereby asset owners may wish to have more integration of ESG elements in their portfolios but are unable to implement easily as they lack the tools and resources to assess investment opportunities with this added lens.
Asset classes such as private investments are illiquid and require large upfront capital. Therefore, pooling resources through a manager, or co-mingled fund, will allow an investor to achieve greater diversification of deals.
As noted before, asset owners have been outsourcing their portfolios for a long time. For those that are still managing things purely in-house, there has to be a regular review ... to keep up with market changes and cope with the reporting requirements.
There will be asset classes in which in-house teams may lack expertise or ... experience, and for those, the asset owner should balance the benefits of having exposure to those assets versus the need to rely on a third-party provider to supply it.
Working with multi-manager solution providers is a half-way house, as there is typically a lot of advisory support at the strategic asset allocation level.
[It] allows the client to implement the asset-allocation decisions much more quickly as the provider can lend a ready-available solution formed from a diversified pool of managers and will also have a large team to handle the onboarding process, as well as ongoing reporting support for amending the manager line-up when necessary.