Redefining Asian insurers' investment portfolios

David Lomas is global head of the Financial Institutions Group at Black-Rock.

By David Lomas

As we begin 2014, there is no doubt that insurers globally are faced with a unique set of challenges, both old and new, that will drive them to re-examine their investment portfolios and overall approach to asset allocation.

Despite the real challenges posed by low yields, shrinking profit margins and regulatory uncertainty, we are seeing investment trends that if executed properly, will position insurers for income growth this year.

It’s no secret that the current “low for longer” fixed-income environment is turning the screw another notch for insurers globally who rely on income from their investment portfolios to fund their daily business operations as well as support total earnings.

Faced with a very real need to generate more income this year, insurance companies globally are likely to continue to revisit investment guidelines and take a more flexible approach to investing, including embracing non-core assets.

In Asia, the lack of investment grade, long-maturity fixed income assets, coupled with the low interest rate environment, will continue to encourage insurers to look outside of home markets.

The exceptions may be Korea and China who experience one of the higher interest rate environments when compared to their global peers. The challenges confronting the industry have also compelled global insurers to take a serious look at new asset classes for ways to diversify risk and return away from the traditional sources.

Insurers are finding that they tend to hold more liquidity than they truly require and hence are looking at asset classes that provide an illiquidity premium. Those insurers are likely to reallocate toward assets such as infrastructure debt, real estate debt, bank loans, CLOs and other income producing assets.

In addition, interest in absolute return strategies such as hedge funds and private equities, are also on the rise. In a 2013 study by Barclays, “Searching for Premium Returns,” 60 percent of insurance companies surveyed indicated they plan to increase allocations to hedge funds, and those already invested in hedge funds do so “to achieve uncorrelated return stream and/or higher risk-adjusted returns.”

Asian insurers have similar investment challenges and goals that have led even the historically more conservative companies to explore new alternative asset classes. The key to such strategies is due diligence, risk management, and adequate scale in order to build a robust portfolio.

Given the complex nature of these assignments, insurers are opting to outsource alternative mandates to third party managers such as BlackRock, which has seen alternative assets increase fivefold over the past three years.

An increase in the use of exchange-traded funds is expected as insurers continue to seek efficient access to new assets, as well as diversifying markets that often complement core fixed income assets.

We believe insurers will continue to use ETFs to solve for a host of investment objectives, including rapid beta exposure, volatility hedging, tactical asset allocation and duration management.

While the use of ETFs have yet to become mainstream in Asia, we expect their popularity to increase as evident in a recent survey conducted by the Economist Intelligence Unit that a significant number of Asian insurers believe the ability to implement a tactical asset allocation framework is of key importance in the current investment environment.

And for those in regions who are already users of the instrument, many cited the flexibility ETFs offers to make tactical adjustments and interim beta/cash equitization as key reasons for their continued use.

In 2014, insurers will also reconsider their equity allocations, paying more attention to controlling volatility and portfolio diversification to better manage downside risk.

Minimum-volatility strategies are likely to become a larger holding within insurers’ equity portfolios and to improve diversification. Insurers might also consider shedding some of their home-country equity bias.

We expect this theme to resonate well with Asian insurers, especially as many rely on equity returns to support investment results and drive corporate profitability.

However, those results can be unpredictable given the volatility of the Asian equity markets.

Minimum-volatility strategies can help improve the risk and return profiles of equity holdings, and while insurers in region do have a home-country bias, some have made steps to diversify their investments. On the whole, there is certainly room to do more.

The last and likely most important consideration for insurers in 2014 is a capital-efficient and regulatory-optimized asset allocation process that will ultimately affect investing activities across asset classes and geographies.

In the U.S., the Own Risk and Solvency Assessment (ORSA) for example, will encourage more insurers to reevaluate and upgrade their investment risk management systems, similar to the trend we have seen in Europe in preparation for Solvency II.

While it is uncertain to what extent Asia will follow suit, we have already begun to see keen interest from insurers to learn about the potential implications should global developments make their way into the region.

Many countries have or are moving towards a risk-based regulatory framework and most expect the eventual adoption of higher regulatory standards given the Asia’s growing importance to the global insurance industry.

Insurers with strong capital positioning will be able to take advantage of a broader investment universe into higher-yield non-domestic assets.

David Lomas is Global Head of the Financial Institutions Group at BlackRock, which manages approximately $320 billion in assets for insurers.