Matthew Smith: I look after our insurance client base. We have 150 insurance clients, and just under £200 billion of insurance AUM, which means it's half of the overall AUM of the investments group. Next year is the 200th anniversary of our insurance asset management capability.
We're the largest independent manager of insurance assets that used to be an insurance company. As a result, it's integral and core to our firm's DNA and our ethos.
We have three main teams supporting insurance clients. The first is relationships and service, which is where I sit.
Then we have fixed income, which is the most important asset class that insurers hold. Thirdly, there is Insurance & Pension Solutions, a team of qualified insurance actuaries who help our clients tackle some of the most complex investment challenges.
Daniel McKernan: I’m responsible for fixed income insurance solutions. We set up this team earlier this year to bring together a number of capabilities into one place. My team manages all of the buy and maintain mandates for our global insurance clients, and all of our asset-liability management mandates for insurers sit within Fixed Income Insurance Solutions. We allocate between currencies, between developed and emerging markets and, increasingly, between public and private markets. We effectively operate like the fixed income teams you’d find within an insurer, and that’s where a number of us got our start as investors.
Dan: Investment grade credit spreads are getting down to 12-month, if not multiyear, tights.
We think that credit makes sense from a yield perspective. We're getting to a point where it's hard to see spreads getting tighter. It might be a slow grind. A rate-cutting cycle means a slower growth cycle, which tends to be quite good for investment rate credit.
It's hard to see us pushing too much further on these levels. Clients still want as much yield at as low risk as they can get. This means, understandably, clients are looking at private credit as an alternative.
If you look at private placements, we've managed to get a 41 basis points pick-up over a comparable yields and maturity investment grade basket, for example.
It’s understandable that insurance investors would move in that direction but there's a trade-off – the positives are you help get the structure that matches your cashflows, but you’re locked into that bond for the life of the loan.
Weighing up the pros and cons, at this stage in the cycle, it does make sense that investors are still looking to private credit.
Mat: There's the structural support of demand for private credit coming from the growth of Bulk Purchase Annuities (BPA).
If you look at the UK, there's a need for long-dated credit to match those liabilities. The best way to do that, to attune your cash flows to your liabilities, is to be precise with what you want. Doing so in the private markets is easier because you're able to negotiate with borrowers to get the right terms to match the liabilities.
"What we don't want to do is lose that discipline of saying the
spreads are not enough, or the structure is not right."
Dan: We look at this on a holistic level. The hit ratio, which is around 15% to 20% means for every 10 deals that we'll look at, we might do one or two of them.
One of the potential downsides is that, as everybody starts looking at private credit, we need to be sure about the credits we get exposure to. The way we look at private credit is: are we getting sufficient pick-up, whether it be spread or diversification, into names that we like versus what we’d get in public credit?
Commercial real estate lending (CREL), currently, is a great place to be even though it’s lagged a small amount. We look at where public property companies are trading, and they've done well.
Therefore, we think over the next 12 months, there are opportunities in the pipeline. But what we don't want to do is lose that discipline of saying the spreads are not enough, or the structure is not right, or we don't like the fundamentals.
Our team is disciplined, and we maintain this by ensuring there is independent input in the decision-making process. Each deal has to go through a committee so we can maintain that discipline.
Mat: We believe our 200-year history helps us do better than others. We grew up as the investment department of an insurance company. That means that when I show the portfolio manager an insurance client’s investment guidelines, I’m not asked why we’ve set things up in a particular way. There's an immediate appreciation that the reason the mandate is structured is due to Solvency II or whichever regulatory environment the insurer is operating in.
It all comes very naturally to us at abrdn.
Dan: What we like to do is take a holistic view of an insurance client’s assets and liabilities, their regulatory capital requirements and their overall risk appetite. That sounds like an obvious thing to do, but that really only comes naturally to abrdn Investments because we were an insurer.
"A lot of what we do is highly tailored to our clients, and we
pride ourselves on being able to respond to that."
We really want to be viewed as an extension of an insurer’s investment team, where we can discuss their challenges and actively find ways to support them. It’s a very different approach to being handed a mandate, working to the strict letter of that mandate and never actively engaging with the client to get the best possible perspective of what they’re facing.
A lot of what we do is highly tailored to our clients, and we pride ourselves on being able to respond to that. Again, being set up to do that comes naturally. We’ve been an insurer with different sets of liabilities and different business lines; therefore, our starting position will always be trying to engineer a bespoke solution for our insurance clients.
Mat: Dan and I have both been in this market a long time. We’ve seen asset managers come into the marketplace to work with insurance companies, and then move away again, whereas we've been consistent.
Where we are today, the migration from direct benefit (DB) pension schemes over to insurance companies has meant that a lot of asset managers who were previously focused on the DB marketplace have had to rethink. No doubt about it, all of the major strategic consulting firms are telling those asset managers that insurance is the place to be - so what does it mean?
It means that you have the potential, as an insurance company, to work with managers who might be prepared to offer a package of asset classes because they're looking to build scale in that space.
"From an insurance company perspective, the governance and reporting
burden does decrease if you have more assets with fewer managers."
Competition is a good thing. It's helpful in marketplaces. Yes, it has led to a reduction of fees because if you're trying to quickly build scale as a new entrant asset manager you're going to be competitive on fees.
As new capital and entrants come in – especially private equity-backed firms – the growth of demand coming into this space will keep growing.
It should lead to innovation as new firms come in with different ideas and angles. That's a good thing as well. It's good to be kept on your toes. No asset manager should be complacent.
From an insurance company perspective, the governance and reporting burden does decrease if you have more assets with fewer managers.
Dan: Naturally, insurers will look for fewer managers because the regulatory and reporting burden is high.
When insurers ask, “Can you provide reports on x, y and z?”, we know we can. Everybody in the team understands why an insurer has to ask for this. And if we can find one set of reports that covers multiple asset classes then that's easier for them.
Mat: There's a lot involved with looking after insurance clients. It's extremely technical. You need to be resourced for that. With insurance clients comes this plethora of responsibilities, whether it is reporting, or the way that insurance companies ask a lot of questions because they have a governance requirement behind it.
I joke with my colleagues who look after pension schemes and interact with them comparatively infrequently that I get uncomfortable if I haven't had a conversation with my insurance clients every day - often multiple times a day - because it really is that involved.
Once you learn and accept that then you’re probably set up for success. But I'm not sure every asset manager gets that.
Dan: Insurance companies regularly have an investment income hurdle that they need to beat. They also tend to have an average credit quality for their portfolio of A- or better, with large holdings of public investment grade and government bonds.
When you say, ‘private credit’, most people think of direct lending, a sub investment grade asset class relevant only to the alternatives bucket. For context, 1.61% of UK insurer’s bonds were rated high yield in the most recent Bank of England data, compared with just under 97% rated as investment grade.
That tells us that, over time, investment grade private credit could replace part of an existing public investment grade in much larger size, and with much greater overall investment income impact than direct lending can provide.
In subscription line fund finance and real estate debt, for example, investment grade deals can offer spreads up to 300 basis points. With BBB spreads briefly dipping under 100 basis points this month, we believe that’s a significant opportunity for insurers.
"You need to be extremely disciplined and have both principle protection
and the prudent person principle at the heart of your process."
But it’s not just a return story. IG privates often come with better downside protection, in the form of covenants and collateral, than the public universe offers. They also tend to offer diversification compared with often concentrated holdings (especially for shorter-dated liability insurers whose focus is often forced onto financials).
In the UK, the BPA market has definitely led the way on this, with certain insurers targeting 50/50 public / private portfolios. Insurers with catastrophe risk, for example, will never get to these levels and it’s not a free lunch. You need to be extremely disciplined and have both principle protection and the prudent person principle at the heart of your process, but overall, we expect this to be a key recurring theme for European insurance in the next few years.
Mat: I often have to remind myself that investing in private credit isn’t a new phenomenon for insurers. Insurers were among the first investors in bonds, back when there was no public market, and everything was private.
However, if we look at the fixed income landscape today, you’re presented with a vast universe of possible investments. That comes with an education hurdle, both at an asset class level, and when it comes to how they fit into the insurer’s strategic asset allocation. At abrdn Investments, we’re here to support insurers with that journey, and help them realise the end value in what they invest in.
