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Chiang notes insurance companies needed a 5% yield to match their ongoing liabilities. With domestic government debt yielding 3% at best, he argues that it would be unrealistic to expect any asset manager to generate this return from domestic asset classes. Even if they did, and the actual figure was likely to be less than 2.5%, he argued, this is still far short of the 5% yield insurance companies require to meet their liabilities.
He made his remarks yesterday in Taipei as a speaker at AsianInvestor magazine's inaugural Taiwan Offshore Investment Conference.
"It would be miraculous," he says, "for any manager to achieve 3% a year in Taiwan and, in terms of asset liability and duration management, there are far more opportunities offshore. The US 10-year treasury bond yields 4.5%. There is nothing in Taiwan that comes even close but by using offshore investments, including CDOs, notes and equities, we can generate more than our 5% funding costs.ö
This, Chiang argues, poses a threat to the viability of TaiwanÆs insurance industry even as it increases the level of investments held offshore close to the maximum allowable limit of 35%. Official figures have not yet been released but it is estimated that 2006 saw insurance funds increase their international exposure to 30%.
"Pension funds are more aggressive," he adds. "And in the last couple of years they have been more aggressive than insurance companies. Government pension funds can afford to be so as they have bottomless pockets."
There are, however, ways around the existing quota. For example, onshore investment-trust companies offer a full range of international investments. These products, if denominated in New Taiwan dollars and locally domiciled, don't count toward insurers' quotas. Nor do many structured products that are also denominated in the local currency. Chiang would not estimate how much Taiwan's insurers have invested internationally via local-currency products, but given that roughly two-thirds of Taiwan's funds industry is now in overseas products, the figure could be substantial.
Nonetheless this is an indirect route and insurers would prefer to have a freer hand tapping foreign-currency products, offering them a broader universe, flexible costs regarding hedging and the benefit of diversifying into other currencies.
Chiang acknowledges that Taiwan's politicians have some legitimate concerns about increasing the limit on overseas investment, primarily the fact that it would result in capital outflows.
"The major concern would be the flow of money offshore," he says. "This could have an impact on domestic government bond income. But all of TaiwanÆs biggest insurance companies are preparing statements to pass to the legislature suggesting how they can resolve this issue and make it possible that no capital leaves the country.
For example, investors can swap their overseas investments back to New Taiwan dollars, mitigating currency impact. But institutions must be careful not to fully hedge, as the high costs could erode all the gains from international markets.
Chiang also suggests that alternative assets, including collateralised debt obligations and structured notes, could help generate returns well in excess of the 5% required to keep insurance companies afloat.
But flexibility can pose as much of a danger as stasis, he argues, as the introduction of high-optimisation strategies such as hedging may reduce capital costs but will also, inevitably, increase risk.
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