Risk appetite and new asset classes were the leading topics for Chief Investment Officers (CIOs) and other senior finance figures from the industry when asked about their views on portfolio construction and investment opportunities.
This was the conversation at the recent Insurance Investor Live Europe in London event, which included the “Portfolio construction and exploring asset price opportunities: Diversification in the asset mix, new access and exit to private markets, and future of ALM” panel discussion featuring Corrado Pistarino, Chief Investment Officer, Foresters Friendly Society, Mark Wood, Head of Credit Risk, Aviva UK & Ireland Life, and Tracy V. Maitland, President and Chief Investment Officer, Advent Capital Management, as well as representatives from Pacific Life Re and Phoenix Group.
The panellists discussed several areas, including whether the repricing of term premia on the yield curve would affect asset valuation across all asset classes as investors reassess their appetite for risk-taking in 2024.
The discussion is featured in the Insurance Asset Management Europe 2023 report, now available to download.
For highlights of the discussion, read below.
Tracy Maitland: We manage about $9 billion, and one-third of the clients we have are insurance companies. When you look at the most capital-efficient, return-seeking strategy that one can consider, that’s also overlooked, it’s convertibles. If you go back to 1973, convertibles have similar returns to equities, but these returns have been achieved with only a portion of the risk. Insurance companies are typically conservative by nature.
"[Convertibles] are more liquid than the high-yield market, which is astonishing
because the dealers can hedge themselves with stocks, bonds, and options."
Then, if we talk about risk-based capital, in the US you have the National Association of Insurance Commissioners (NAIC) and in the UK you have Solvency II. When you invest in equities as an insurance company, the risk-based capital charge, or haircut, for convertibles is significantly less than for equities: 25% versus 35-49% depending on whether they are developing country equities or not. The point is, that you can achieve equity-like returns with only a portion of the risk and with only a portion of the capital charge.
Convertibles represent a half-trillion-dollar market. They are more liquid than the high-yield market, which is astonishing because the dealers can hedge themselves with stocks, bonds, and options. Yet, many people don’t consider them because they are not mainstream.
Mark Wood: It is outside of my risk appetite. Investment grade, predictable cash flows in terms of our asset allocation are still heavily underpinned by commercial real estate, private corporate debt, structured finance, infrastructure, and lifetime mortgages.
Taking advantage of volatility, the tension between public and private spreads, and digging into the public markets when we feel that yields are attractive enough. The challenge for us is diversifying outside of the UK into Europe and the US, which is something we’re trying but haven’t quite accomplished yet.
Corrado Pistarino: With few exceptions, I do not see capital efficiency as a key driver for investment decisions. It may lead to sub-optimal capital allocation, leading to underperformance. Real losses eventually consume solvency capital even if risk budgeting was done on favourable terms.
"Looking at our portfolio, we have an allocation to short-term trade
finance investments, for which we put 3% of solvency capital."
Of course, capital efficiency remains a consideration during the investment process. We have invested a significant portion of our portfolios in private assets over the past few years, probably more than our peers. Indeed, one may argue that every private asset investment is a form of capital arbitrage because there is no mandatory capital requirement for leveraging risk, the risk that a sudden de-leveraging impulse across the market could lead to fire asset sales at heavily discounted prices.
The picture is fairly nuanced. Looking at our portfolio, we have an allocation to short-term trade finance investments, for which we put 3% of solvency capital. I believe that is more than what we should, considering the historical default experience for this asset class; yet other observers may look at it as a form of capital arbitrage. The same can be said for private debt: if the Investment Grade (IG) index trades at 1.5% and that asset pays 6%, the remaining 4.5% is a yield pick-up which is not mirrored by extra capital absorption. As I said, one could argue that private markets investments entail a form of capital arbitrage because of the illiquidity risk that could become apparent in adverse scenarios and that isn’t accounted for in current solvency provisions.
In general, we try to make investments because we think that the investment will produce the expected level of return consistent with the amount of risk-taking. We are in a fortunate position because we don’t have a lot of constraints in our investment strategy. We do not have long-term liabilities that would require a matching-adjustment approach. As an example, we don’t invest in infrastructure debt, which I consider to be overpriced, but it is almost an inevitable allocation for matching-adjustment portfolios. On the contrary, we invested in infrastructure equity, where we expect most of the value to be.
