Asia’s fixed income and currency swaps markets will need to develop further if international investors are to really help fund the region's infrastructure and debt-funding needs, believes the chief investment officer of Prudential Corporation Asia (PCA).
In an interview with AsianInvestor in mid-December, Stephan van Vliet said insurers like his organisation should encourage the development of local currency bond markets.
“We can play a role throughout the region and consider other fixed-income assets, possibly in combination with multinational developments banks and government bodies,” van Vliet said.
This is a self-interested move, given that life insurers typically invest over 80% of their assets into local fixed-income instruments. Yet it’s notable that many Asian bond markets are still relatively thin or lacking in long term maturities. Deepening these markets would help PCA, which had £86.91 billion ($110.72 billion) in regional assets as of June-end 2018, to better invest the money from its growing business, while giving borrowers a better avenue to fund themselves.
PCA has already been actively trying to add new tools to Asia’s debt box, particularly in the infrastructure space – an area where it wants to invest more heavily.
Its wholly owned asset-management division, Eastspring Investments, bought bonds to support a $500 million infrastructure co-investment programme in June 2017 that was arranged by the International Financial Corporation. This investment came after PCA set up a direct infrastructure investment team in Eastspring around four years ago.
Improving infrastructure financing is widely considered key to ensuring more Asian projects get off the ground; in 2017, the Asian Development Bank estimated the region had a financing gap of $459 billion a year. Add in health and education investments and this gap rises to $907 billion.
Van Vliet argued that greenfield infrastructure projects usually require credit or political guarantees from multilateral institutions during construction because they're seen as too risky for institutional investors. But once constructed, these projects can gain the support of investors through more regular bond funding, provided local markets are developed enough.
“At the end of the day we are an insurance company and have assets from many policyholders. We can only take risk in a gradual way and expand this as some of these [supportive] guarantees are taken off,” he said.
PCA typically invests into infrastructure through funds. These are generally brownfield, focused on investing into existing infrastructure, but van Vliet noted that parent company Prudential’s latest infrastructure fund in the UK, which closed in 2018, is focused on greenfield assets.
He believes there is the potential to develop such investments in Asia too, despite the greater political and financial risk in the region.
“It’s complicated to get money to work in this sector in Asia but ... there’s a tremendous opportunity that could be a win-win for the [investor and issuer]," he said. "If you think of infrastructure investment cash flows and, ultimately, most revenues that come through in local currencies, we can match our liabilities on a like-for-like basis [by investing in such assets].”
ADDING FX OPTIONS
Big infrastructure investments would also likely require international funds too, which is why van Vliet said he wants to see more efforts to develop currency swaps markets in the region too.
“International pools will be more willing to invest in regional currencies if they can swap back into their own currencies over longer periods of time,” he noted. “So it’s worth working with the authorities to develop swap markets.”
He noted that adding depth to swap markets at five years or longer would help insurers and other fixed-income investors make longer investments into local Asia markets – and help locally based institutional investors more easily buy offshore debt too.
Indeed, van Vliet believes several Asian markets could do with making it easier for local fund managers and asset owners to invest offshore. While this is easy in markets like Hong Kong and Singapore, PCA also operates in China (via a joint venture), Indonesia and Vietnam, where the rules about offshore investing are far more stringent.
“Clients still run concentration risks onshore, so when allowed [to offer them offshore investing options] we should right away offer them,” he said.
He said PCA is speaking to local regulators about promoting more offshore investing options, to give customers more options.
CAPITAL RULES CHANGES
Meanwhile, like most of his peers, van Vliet is focused on the shifting regulatory landscape for insurers, particularly when it comes to the rules around holding capital.
The advent of Solvency II capital regulations for insurers in Europe has prompted regulators across Asia to look to update their rules too. China is doing so, while Thailand has become one of the fastest movers to introduce a new risk-based capital (RBC) model.
For PCA, the rules are less likely to have a major impact, given that it already has to subscribe to Solvency II due to the fact that parent company Prudential is UK-headquartered. But the shifting of the rules is likely to throw up some headaches. Thailand offers one example; van Vliet said the speed of its regulatory shifts has caused some frictions for insurers.
“Thailand introduced RBC capital rules that charge for [asset-liability] mismatches but the local bond model doesn’t necessarily allow us to hedge interest rate risk [as effectively as we would like],” he told AsianInvestor.
Capital rules changes aside, the CIO’s key immediate challenge is to navigate the increasingly stormy conditions enveloping the world’s capital markets.
“The range of outcomes is really significant at the moment, so it’s important to do our tactical asset allocation carefully,” he said.
And if equity volatility were to crank up again, it is likely PCA would become even more cautious, he added, noting how the insurer had been neutral on equity investing for most of 2018 after being initially overweight at the start of last year.
Meanwhile, PCA is keeping an eye on benchmark 10-year bond yields, given its long-term focus and disposition to invest primarily into debt. “Gradually rising credit is good for us,” van Vliet said, but he agreed that the rate-hiking period of the US Federal Reserve might be nearing an end in the coming year.
What does that mean for PCA? “Now might indeed be a good time to buy long-term bonds.”
For further insight and analysis into how Asian insurers are seeking to invest and navigate regulatory changes, look out for AsianInvestor's 6th Insurance Investment Forum in Hong Kong on March 12, and our inaugural Insurance Investment Forum in Singapore, on March 14.