How insurance investors can manage private assets in a diversified portfolio

Andrew Putwain: Has there been a shift in the way insurance companies are implementing private assets into their investment portfolios?

Christian Thompson: Yes, with the exception of the larger and well-resourced life/annuity writers that have been investing in private assets across their investment book for many years, insurers investing in the private markets have historically done so outside their matching ALM, or ‘core’, portfolios. Incorporation of these assets has been a yield play to combat the fact that core portfolio yields have been grinding ever tighter anchored by central banks’ ‘lower for longer’ interest rate guidance.

"We see there to be a fundamental shift underway in the way private

 assets are considered in the context of insurance portfolios."

Now that inflation is hitting in a real way, policymakers are taking action to bring inflation under control by rising short-term interest rates and winding back pandemic-era stimulus. This new economic environment is expediating the insurance community’s migration into the private markets where portfolio diversification, protections and covenants are just as coveted as yield in today’s environment. According to a report from Blackrock Global Insurance Reports from 2021, 93% of insurance companies report that they will be looking to reallocate part of their core fixed income portfolios over the medium term.

We see there to be a fundamental shift underway in the way private assets are considered in the context of insurance portfolios. For numerical reference, globally, insurers are expected to double their private market allocations in the space of two years, with allocations increasing to 14% of overall portfolios by next year, said the Blackrock Global Insurance Reports from July-August 2019. In absolute terms, we estimate that this could equate to potential investment over the medium term of c.€850 billion to €1 trillion from European insurers alone.

A lot of this demand, we think, is going to come in the form of assets that are investment grade and have a similar duration as the core portfolios.

Andrew: It’s clear that there is a large and increasing demand for private assets from insurance investors, but is the industry able to cope with the weight of capital coming to market?

Christian: The industry is shifting quickly through the gears of private asset allocations.

"Given the weight of capital coming to the private

markets supply constraints are exacerbated."

Due to the amount of insurance balance sheet assets in the market, even a small industry-wide reallocation will result in a strain on the supply-constrained private markets. It is important, therefore, that insurers and their asset management partners work together to ensure portfolios are appropriately constructed to try and ensure successful and efficient deployment into private asset classes.

Given the weight of capital coming to the private markets, which we see incidentally across the institutional landscape, supply constraints are exacerbated (particularly in popular asset classes) and overly constrained, single asset class mandates can lead to slow and frustrating deployment time and sub-optimal portfolios.

It might be thinking more holistically about private allocations, treating them more like public allocations without artificial caps but instead seeing the private markets as one opportunity set where managers can build a flexible but constrained solution

Andrew: Are there private asset classes that are well suited to matching insurance company liabilities?

Christian: Yes, there are. It is important when looking to invest in private assets that match liabilities that the assets have characteristics in keeping with core portfolios. i.e., they are of investment grade quality and offer a similar duration profile as that of the core book. Asset classes where we are seeing considerable interest from the insurance community in the context of matching portfolios are real estate debt, residential mortgages, and infrastructure debt.

Andrew: What are the barriers preventing insurance investors from accessing private assets and how can they be overcome?

Christian: There are two main barriers when it comes to effectively accessing the private markets. The first comes from the mandate creation itself.

Typically, insurers who have identified the private markets as an area where they would like to invest assets tend to choose a single asset class to deploy into. If additional constraints and exclusions are then added the mandate can become increasingly difficult to deploy.

Slow and frustrating deployment times can also have a knock-on effect on future private asset investment ambitions. Insurers must work closely with their asset management partner to build mandates that are truly reflective of the market opportunities to improve the outcomes of portfolios.

"It is important for insurers to spend time setting up their private asset

investment programme in a way that is in keeping with market dynamics"

The other barrier can be internal. Regulatory demands, Prudent Person Principle (PPP), own risk and solvency assessment (ORSA) considerations, for instance, although being incredibly effective controls by their nature can slow down investment ambitions. The private markets are typically opportunistic, and to extract the most value, being nimble is important.

This problem is particularly noticeable in single asset class allocations as once all the risk controls have been satisfied to introduce a new asset class into the investment portfolio, one is then to some degree at the mercy of the spreads available in that asset class.

Again, it is important for insurers to spend time setting up their private asset investment programme in a way that is in keeping with market dynamics to ensure efficient and optimised asset deployment.

Andrew: What do you think is the medium-term outlook for insurance investment portfolios?

Christian: It is clear that allocation to private assets is structural as opposed to transitory but what is most striking is the changing way that insurers are looking to incorporate private assets into their portfolios. i.e., acting in more of a core role. For several years, Dutch insurers have incorporated certain private credit assets into their core investment portfolios, as they have sought to improve the risk/return profile of their investments, beyond what they can get from their traditional core holdings.

Dutch insurers have a significant allocation to ‘mortgages and loans’, which, according to EIOPA’s European Insurance Overview Report 2021, can represent 25% or more of their investment portfolios in some cases. Over the years, these investors have shifted towards these higher-yielding assets, with the low capital charges on offer proving attractive while default rates on mortgages (residential and commercial) have remained historically low.

We expect other European markets and insurers therein to follow suit and utilise private credit in this way. The latest market estimates suggest 93% of global insurers are aiming to reallocate part of their core fixed income portfolio, typically between 10% to 20%, to alternative strategies exhibiting ‘core-like’ characteristics, of which half is predicted to go into illiquid credit; with multi-asset and multi-credit solutions set to make up a good proportion of the reallocation as well.