Indian insurers have been slow to warm to alternative assets but with portfolios heavily tilted towards bonds and yields heading lower in the long-term, that looks set to change.

It's a view backed by some local institutions, among them Kotak Life Insurance, which has more than 20 million policyholders to its name and is part of the Kotak Mahindra group, the financial empire built up by Uday Kotak, one of India's richest people. 

If inflation targeting by the Reserve Bank of India acts succeeds in reducing long-term inflation in India, then that will compress local bond yields and lower investment returns, thinks Kotak Life's chief investment officer Sudhakar Shanbag, making it harder for insurers to match their liabilities. 
 
"With this background, it will be imperative over time for Indian insurers to look for alternatives as an asset class and have a meaningful allocation for the same as a portfolio diversifier and return generator,” he told AsianInvestor last week.
 
Currently, the yield on benchmark 10-year Indian government bonds is hovering around the 8% mark -- a four-year high due to the rising cost of Indian oil imports and the depreciating rupee, which on Tuesday hit a fresh all-time low of Rs71.53 versus the US dollar.
 
However, that does not detract from the idea that the long-term trend for yields is probably down, believes Shanbag, casting an unfavourable light on the current mix of Indian insurer investments.
Sudhakar Shanbag
 
Indian insurer portfolios in general are split into traditional and unit-linked varieties and traditional portfolios are further broken down into life funds, pensions and general annuity funds.
 
Local regulations require companies to invest a minimum of 50% of a life fund and 40% of a pension or general annuity fund in central government securities. Insurers must also invest up to 15% of their portfolios in social infrastructure-related instruments, which are often fixed-income instruments too.

“In addition to the regulatory minimum in terms of [government securities] and infrastructure, which form a reasonably large portion of an Indian insurer’s portfolio, we observe that, on average, across the top-10 insurers, direct equity allocation is in the range of 10% to 15%, with the market leader at over 20%,” Shanbag said.

That makes traditional portfolios quite heavily-tilted towards bonds – not an ideal situation when inflation rates are expected to moderate in the long term, he said.

With India adopting inflation targeting, consumer price inflation is expected to be reined in around 4% (plus or minus 2%) over the longer term, progressively bringing down bond yields.

Kotak Life, which had about $3.8 billion in assets under management as of August, has started investing in alternatives such as direct commercial real estate, private equity as well as some alternative investment funds, such as private equity.

At the end of March 2018, Kotak Life Insurance had about 69% of its assets in fixed income instruments, 12% in public equities, and about 2% in alternatives such as property and infrastructure. Shanbag did not specify how this mix might evolve further.

CHALLENGES GALORE

Shanbag acknowledges that embracing alts will take time for most Indian insurers, unlike their peers elsewhere in Asia, which have been enthusiastically investing in assets ranging from private debt to infrastructure for some time now.

Smaller Indian insurers like Edelweiss Tokio Life Insurance and Reliance Nippon have already waded into the alts market, while others such as Canara HSBC Oriental Bank of Commerce Life Insurance has said it is in the process of exploring alternatives.

But in the case of Indian commercial real estate, say, local insurers have made only selective direct investments.

“Collectively ... we have not observed any attempt to explore large deals in this asset class across the country. Real estate investment trusts and fund routes have also not come up in a big way for insurers to explore,” Shanbag said.

Still, appetite is slowly growing, according to Shobhit Agarwal, Mumbai-based chief executive of real estate-focused investment banking consultancy Anarock Capital, who notes robust demand from institutional investors to build assets across different property segments including office, retail, warehousing and logistics.

Such investments offer cap rates of between 8% and 9% and total returns of around 15%, he told AsianInvestor.

Cap rates, short for capitalisation rates, is the ratio of a property's net rental income after operating costs to its estimated value and is a metric commonly used within real estate investment circles and comparable to bond yields.

Similarly, institutional interest in the Indian infrastructure sector is also gradually building, potentially helped by the introduction in India last year of infrastructure investment trusts (Invits).

Like their property equivalent, real estate investment trusts (Reits), Invits are listed securities that pool money from investors to buy assets that can provide a cash flow over a period of time and have certain tax advantages.

While some large global investors such as the Canada Pension Plan Investment Board (CPPIB) have cautiously embraced Invits, Kotak Life Insurance remains relatively sceptical.

“The performance of infrastructure and real estate in India has been very patchy and other lending institutions have had to take some write-offs across this sector,” he told AsianInvestor. “The initial listed performance of Invits has also not been encouraging, which has not helped in developing this market.”

There are currently three Invits in the market – IRB Invit and India Grid Trust, both of which were publicly listed and are trading below their initial public offering prices in 2017. Indinfravit, which debuted via a private placement, is the only one still trading marginally above par.