Investing in alternatives can be trickier for smaller insurance companies, says Corrado Pistarino, Chief Investment Officer at Foresters Friendly Society.
Speaking on a panel at the Insurance Asset Management Summit in London to an audience of insurance investors he explained: "I work for Foresters which is a mutual and has a very small balance sheet.
"Working for a very small insurer, the challenges are the same as any of the bigger insurers, but, to some extent, they are more magnified.
"For instance, in regard to market access, the minimum size for some of these investments might be too high for us so we cannot access it."
"If I have a sterling denominated balance sheet and buy an asset for 15 years,
the currency exposure will be too expensive in Solvency terms"
Another challenge for smaller investors is currency management, particularly since the Solvency II regulations came into force.
Pistarino explained: "There is also the currency issue which is very pressing because as an investor I would have a very strong preference for global propositions and if I have a sterling denominated balance sheet and buy an asset for 15 years, the currency exposure will be too expensive in Solvency terms so what I would need to put in place is effectively a hedging program."
"Having a hedging program for an asset is much more engaging than buying the asset itself because you are essentially engaging the operational side of the company for a very long time to run something that is not terribly complicated."
The third biggest challenge is around investment governance. Pistarino explained that because Foresters has a very small investment team, there are hurdles to be overcome before expanding into new asset classes.
For instance, the insurer needs to establish whether it has the right capabilities and understanding, as well as whether it needs to develop any independent valuation models - which could cause problems from a resource constraint perspective.
"We are conscious about the constraints that are more pressing for us
than for other players in in this area."
Despite these challenges, Foresters has made some strides in alternative investments. The organisation is invested in real estate and SME loans, and TS planning to invest in more alternatives both in terms of cashflows as well as some growth within its portfolios through equity investments.
Pistarino commented: "We have a lot of interest in these assets, but we are conscious about the constraints that are more pressing for us than for other players in in this area.
"If, for instance, I bought an SME proposition... it is not just the assets, I may have liquidity lines, currency exposure and then I have to go to my actuarial team, which is very tiny, and for one single asset they have to spend two days to complete the capital so it isn’t very inefficient.
"Unfortunately, there are constraints that may not be common for larger insurers but for us is very pressing."
He said that cost is another very important issue, particularly for smaller insurers who need to rely on specialised managers that are ideally the best of breed and there are agency costs.
"You want to carry out your due diligence as thoroughly as possible,
but it is difficult to identify all of these costs and quantify them."
As well as costs, he points out that you need need to consider whether you have aligned interests with the manager and whether there is any moral hazard that needs to be identified and potentially priced if possible.
He concluded: "From the manager perspective itself, there is also potentially an adverse selection problem that will affect the portfolio so the fact that this is in private markets and that there is quite a level of opaqueness creates a number of agency costs that are much more than just what you are paying on top of fees which could be 80 basis points.
"Of course, you want to carry out your due diligence as thoroughly as possible, but it is difficult to identify all of these costs and quantify them."
