The question of what an investment portfolio needs in the current market and how insurers should look for appropriate opportunities is a large issue that needs nuanced debate.
In a recent Clear Path Analysis webinar, in conjunction with Aegon Asset Management, this issue was discussed with several senior industry figures, including representatives from Lloyd’s, Legal & General, and Aviva.
The webinar now forms part of the new report, “Avoiding the crowds: Unearthing capital efficient fixed income opportunities for insurers”, which is available to download. In the report, Keith Goodby, Head of Shareholder Investments at Aviva, discussed strategies for achieving these goals.
“My main focus is Matching Adjustment (MA) portfolios,” he said when asked what portfolios needed to watch. “We are a long-term spread investor, which means our portfolio is a good mix of public bonds and a variety of private loan asset classes across all jurisdictions in both developed and emerging markets.”
“Like all insurers, we have a net zero ambition: ours is by 2040 but with interim targets of a 25% reduction by 2025 and 60% by 2030.”
Matching adjustments are currently under review as part of the wider consultation with industry over the Solvency II framework changes in the UK. Proposed changes include widening the range of investments that companies may hold in matching adjustment portfolios, expanding the types of insurance business that may claim them, and removing certain limits on the amount of managing adjustments that may be claimed from sub-investment grade assets.
Currently, under Solvency II, the matching adjustment is applied as an increase to the liability discount rate; it is calculated by deducting the fundamental spread from the credit spread on the assets backing matching adjustment liabilities.
With this context in mind, Goodby said that there were three main themes to focus on. “The first is sustainable, green, and transition assets,” he said. “Like all insurers, we have a net zero ambition: ours is by 2040 but with interim targets of a 25% reduction by 2025 and 60% by 2030.”
He added that Aviva, one of the UK’s largest domiciled insurers, has green and sustainable asset targets set at around six billion by 2025. “These are all off of a 2019 baseline, and clearly this short-term green and sustainable assets under management (AUM) is not enough to get us to our 2040 net zero ambition – so we will need more of these assets,” he said.
This refrain has been a common one throughout the industry over the past several years – that slow bureaucracy and a lack of opportunities have hampered goals. The United Nations Principles of Responsible Investment (UN PRI) released a paper that covered the issue and suggested several remedies – all of which were long-term strategies rather than quick fixes. They included further aligning incentives between donors, development finance institutions, and institutional investors.
Goodby said that if he had one plea, it would be for the UK government to facilitate greater support in this area. “Especially if I’m thinking of the US government and what they are doing with the Inflation Reduction Act (IRA).” Even though Goodby said that it “really has nothing to do with inflation and everything to do with supporting or creating a significant tailwind for climate tech, and this means huge £370 billion subsidies and tax breaks.”
The IRA does come with stipulations, though – including that these tech investment companies must have built their products in the US. “So, [the] UK and Europe are in danger of losing those jobs to tech sectors like hydrogen, carbon capture, and battery storage, for example. Both the European Union (EU) and the UK government need to step up to compete and support in this area,” he said.
The second related area is around infrastructure, Goodby said. “Aviva has a strong social purpose, and we do a lot of infrastructure investment, particularly focused on the UK,” he said. “We are crying out for more opportunities to invest in infrastructure – particularly green infrastructure – but the whole process from planning to development to funding is incredibly inefficient.”
As an example, he added that it takes approximately four years to get development consent orders for infrastructure, which is up from two years in 2012, and about five years for renewables to get linked to the grid.
"If we take renewables, we don’t see alignment between the secretary of state, treasury, pensions regulator, the PRA, and the Bank of England.”
This, he said, is in the context of a government “that says they want to decarbonise the grid by 2035”.
“It isn’t going to happen unless we have some material change in the way we look at infrastructure projects,” he said. “I heard someone at a conference say that all of the regulators don’t seem to get together. If we take renewables, for instance, we don’t see alignment between the Office of Gas and Electricity Markets (OFGEM), politicians, the secretary of state, treasury, pensions regulator, the Prudential Regulatory Authority (PRA), and the Bank of England.”
Goodby added that this lack of alignment meant there wasn’t a smooth pathway for infrastructure. “We need them all in a room working out how they can do it,” he said.
The third area he listed was inflation-linked liabilities. “We are buyers of pension liabilities, and they have a lot of various types of inflation linkages, but there is not a lot of inflation linkage in the markets,” he said.
He added that his company got more from private assets than it did from public assets. “On the public asset side, if you exclude gilts, there is very little corporate issuance on the index linked side, and a lot of this is clustered around – dare I say, given the recent news – things like water utilities,” he said. “We need a lot more inflation issuance.”
