Insurers forced to expand their horizons

Institutional asset owners outside the retirement plan landscape continue to seek new sources of alpha in alternative investments, industry experts say.

As of Dec. 31, managers of non-affiliated insurance company assets reported $3.772 trillion in assets under management, a 1% drop from $3.811 trillion a year earlier, according to Pensions & Investments data.

Insurance companies, particularly the large life insurance companies, have traditionally managed their core fixed-income assets internally, which has long been the primary asset class for general accounts and other pools because of capital efficiency requirements.

However, because yields on core fixed income have dropped over the years due to a low-interest-rate environment, more insurance companies must seek expertise outside their organizations to find yield in private markets, said David O'Meara, New York-based senior investment consultant at Willis Towers Watson PLC.

When core fixed income would return 4% or 5%, it was adequate for insurance companies, but those days are long behind, he said.

"Now with the core fixed-income portfolio maybe returning 3%, there's a desire for getting into non-core fixed income or alternative investments whether it be mezzanine debt, real estate or infrastructure-type assets," Mr. O'Meara said. "Those look a lot more attractive when you're comparing them to a 2.5% or 3% return."

Mr. O'Meara said insurance companies have an appreciation for these asset classes, but don't have the internal skill set or apparatus to access them.

"We're working with our clients with that as a premise and foundation for our advice and recommendations to possibly move into these non-core assets," Mr. O'Meara said. "It's taken time for insurers that historically did not invest in these areas. It takes time before everyone sort of coalesces around the idea, that this is what we really need to do to grow our business."

Mike Siegel, managing director and global head of insurance asset management at Goldman Sachs Asset Management, agreed that insurance companies are looking to new areas that require external money management. "They are moving to asset classes such as real estate and private equity," he said. "Historically, those asset classes were a fairly significant yield give-up vs. fixed income, whereas there was a long-term play on appreciation. Now the current yield give-up is far less. Dividend yields are now where fixed-income yields are now."

"Companies are more willing to look at private equity and private real estate to gain longer long-term returns without giving up short-term income," Mr. Siegel added.

Maggie Ralbovsky, managing director at Wilshire Associates Inc., confirmed insurance companies are looking hard to find more yield. "It is really hard to survive on the bread and butter of core fixed income," she said.

Ms. Ralbovsky pointed to infrastructure as an area of interest, with specific potential in public-private partnerships — which she says provides a lot of opportunities for insurance companies — as well as opportunity zone investing.

Opportunity zones were created under the provisions of the Investing in Opportunity Act, part of the Tax Cuts and Jobs Act enacted in December 2017. Under the act, investors can reduce, defer and exempt capital gains liabilities through Dec. 31, 2026, if they reinvest at least $100,000 within 180 days of a sale in a qualified opportunity fund for a minimum of five years.

The prospect of investing in opportunity zones, Ms. Ralbovsky said, is intriguing for insurance companies. "(It's) because they are taxpayers and probably could take advantage of basically the rolling over of their prior capital gains to these (opportunity) zones in these underprivileged areas, so they can actually be very tax-efficient," she said.

John Simone, New York-based managing director, head of insurance solutions at Voya Investment Management, said money managers have taken notice of increased interest from insurers, either expanding existing teams or starting new ones to concentrate on the market.

"The successful ones will build out a comprehensive solutions team focused on delivering in addition to alpha solutions globally (such as) insurance asset management advisory capabilities, specialized analytics/optimizations, dedicated relationship management and specialized reporting," Mr. Simone said.

Mr. Simone cautioned, however, that managers simply seeking to apply solutions from retirement plans, which are total return-focused, to insurance companies, which are focused on yield and capital efficiency, will wind up disappointed.

"Therefore the barriers to entry are often higher than many think," he said.

Sovereign wealth funds, meanwhile, saw a drop in assets managed by external managers according to P&I data, with $1.104 trillion in AUM as of Dec. 31, a 8.1% drop from $1.203 trillion the year before.

State Street Global Advisors, the largest manager of sovereign wealth funds, was no exception to the drop, reporting $83.8 billion in AUM as of Dec. 31, down 20.4% from $105.3 billion the year before.

Elliot Hentov, London-based head of policy research at SSGA, said the drop in AUM is the result of funds losing assets as opposed to any diminished interest in external money management.

He said that despite the incredibly diverse pools of assets with diverse investment needs that make up the world's sovereign wealth funds, what they have in common is an emphasis on further exposure to alternative investments.

For alternatives, their exposures to private equity and real estate have evolved over the past few years, Mr. Hentov said.

"We've seen is that basically sovereign wealth funds are proficient investors wall to wall," Mr. Hentov said. "They obviously have large real estate portfolios, and what you're kind of seeing is second-generation investment capabilities."

No longer purchasing commercial properties in what Mr. Hentov calls "Tier 1" cities like London, New York and others, "they're now buying Tier 2 cities, also into very different types of categories. They may buy a Tier 2 city, they may buy a mix of commercial and industrial. Valuations have gone up in everything, and they've branched out."

In private equity, Mr. Hentov said, sovereign wealth funds have increased their exposure and become more sophisticated, and as sovereign vehicles they're now working as direct partners.

Managers of endowments and foundations, meanwhile, had $818.9 billion in assets under managements as of Dec. 31, up 0.5% from the year before.

Those institutions are emphasizing active management of their assets and are seeking external managers that can provide more niche strategies, said Catherine M. Konicki, Boston-based partner and head of NEPC LLC's endowment and foundation consulting practice.

"The focus for endowments and foundations, and I think that has continued for the past few years, is they are going to be stronger proponents of active management vs. passive management, especially in some of the equity asset classes," Ms. Konicki said.

"They want to focus on high active-share managers. They're going to more concentrated managers with bigger positions, fewer holdings," Ms. Konicki said.

This often means endowments and foundations seek smaller, more nimble managers, she said.

She also noted they continue to be interested in emerging markets equities and spending a lot of time looking at how to invest in China. "Do we invest through the A shares?" she said they're asking. "Or more through the illiquid spectrum in terms of getting exposure?"