Asian insurers seeking external managers amid stable markets, alternatives shift

More stable markets compared with two years ago and the trend of diversifying to alternative asset classes could prompt Asian insurers to outsource more of their investments, sources said.

Insurers globally have been increasing their allocations to alternatives as the era of negative equity-bond correlations seem to have come to an end. A KKR survey found that insurers’ allocations to nontraditional investments are now at about 28.9% of their portfolio, down from 31.8% in 2021 but up from 20.3% in 2017.

Sophia Cheng, chief investment officer of the $400 billion Taipei-based Cathay Financial Holdings, said the proportion of the firm’s portfolio that is outsourced, which varies between 10% to 20%, increases when the firm seeks private market managers.

Another C-level executive at an Asia-based insurer said that it makes sense for insurers with small investment teams that do not have the expertise in specific areas, say real estate, private equity or infrastructure, to outsource these investments.

After outsourcing these specialized investments, the insurer can focus on working with their actuaries on solvency and setting the strategic asset allocation, he said.

At its core, the insurance company’s role is to provide insurance solutions to consumers, so if the cost associated with building up a new team to manage a new asset class is not justified, it makes more sense to outsource, said the executive, who declined to named because he is not authorized to speak with the media.

Sources also noted that some insurers — which tend to be conservative investors — will take more of their portfolio in-house when markets are volatile to have better control over their assets and be more nimble so they can make changes quickly if they need to. Cathay Financial, for instance, entrusts more of the portfolio to external managers during periods of lower global volatility, Cheng said.

Institutional investors have had a more positive outlook on markets compared with two years ago. The S&P 500 reached all-time highs in March, and structural changes, such as the growth of artificial intelligence and the growth of the working-age populations in emerging markets, have driven positive sentiment in global markets.

Many Asian insurers already have exposure to alternatives, particularly in private debt, and some are also planning to increase allocations to the asset class, sources said.

“Our conversations with Asia-based insurance clients reveal that allocations to alternatives can no longer be considered ‘alternative,’” said Robert Ronneberger, the Hong Kong-based head of investment sales for Asia at Mercer.

“It’s become rather mainstream with the majority already allocating to (alternatives). Key drivers include higher cash returns given illiquidity premia, and we should not ignore lower volatility," he added.

Allocations to alternatives have increased compared to five or 10 years ago, even if those by Asian insurers are still not yet on a par with their U.S. or European peers, he said.

Asian insurers' allocation to alternatives was in the low single digits in 2021, but is expected to rise to 10% to 15% of portfolios in the next five years, according to a J.P. Morgan Asset Management report.

The shift toward private markets also means that insurers are now working with multiple general partners. “Given Mercer’s nature as a multimanager, our clients are very keen to diversify across multiple leading GPs instead of working with just one or two,” Ronneberger said.

That said, insurers already invested in private markets have been met with challenges such as cost, resources to access and assess opportunities, and operations, Ronneberger said.

"In many cases, the evolving regulatory landscape adds complexity to aspects such as reporting. As insurers build out their alternative allocations, these operational aspects start to compound," he added.

For instance, a private debt separately managed account that is diversified across several general partners and hundreds of loans globally will face operational challenges such as look-through risk and regulatory reporting.

"However, the current environment's attractiveness of private debt outweighs the reported challenges," he said.

Rapid rate hikes have also left many firms with unrealized losses on their balance sheet, which poses challenges for their investment strategies, he said. “For many of our clients, the increase in rates will have or already had an impact on asset values. Some clients have not reallocated to avoid booking losses, and other are strategic about loss harvesting.”

“Either way, assessing the mix of their current fixed-income exposure and optimizing the portfolio is a priority for many insurers. As a result, there is continued focus on risk — with different nuances by region. An interesting fact about our clients in Asia is that they are more opportunistic, starting to diversify their credit exposure to include high yield, emerging market debt and structured credit,” he said.

Mercer had $489 billion assets under delegated management as of March 31.

Mark-to-market volatility has been a theme on insurers’ minds in recent conversations, said Natasha Mora, Melbourne-based managing director for Asia ex-Japan at Legal and General Investment Management.

“How to manage that mark-to-market volatility of assets and liabilities has been one of the key things. As much as you want to access (alternative assets), you want to do it in a way that mitigates the volatility on the balance sheet,” she said. LGIM managed $1.5 trillion as of Dec. 31.

Measuring mark-to-market values in the opaque private markets is not as straightforward as in public markets, so as a third-party manager, LGIM works to understand their clients’ needs as well as possible, particularly because insurers have very specific regulations to adhere to.

“There are specific circumstances in the context of an insurer’s balance sheet,” she said. It is not only about whether the product presents a fantastic investment opportunity or maybe an impact outcome or a risk-return outcome that investors are looking for, it’s how that investment would behave on the balance sheet, she said.

For some insurers, the higher interest rates have helped their fixed income-heavy portfolios perform.

Today’s higher rates naturally benefit insurance companies, which can invest matured assets at better yields and lock in our assets to get longer-term, stable returns, Cathay Financial's Cheng said. “What we don’t like to see is a sudden rise and a sudden decline, because it always hurts (investors either way) . A gradual movement gives time for everyone to adjust,” she said.

Cathay Life Insurance has 61.8% of its portfolio in international bonds, compared to its 8.1% allocation to domestic bonds. The Federal Reserve's May meeting left policy rates unchanged at 5.25%-5.5%, while Taiwan's benchmark rate was raised in March to 2% from 1.875% .

“We had been waiting for higher interest rates for so long. … After the year 2020, we were very puzzled. The rate simply didn’t justify the risk. After the internet bubble, we had globalization, everything was made in Asia or emerging markets, so costs were down, things were cheaper.

The Taiwan interest rate is still relatively low, “that’s why we need to be a good global investor, and we need to be good in hedging,” said Cheng. “We manage our hedging costs so most of the time it is less than 1.5%.”

Mercer's Ronneberger also observed that some Asian insurers view fixed income as an attractive source of yield on a risk-adjusted basis, particularly as risk premiums for equities reach the lowest level relative to bonds in 20 years.

Portfolio management aside, new standards and regimes launched by regulators across the region have been top of mind for Asian insurers, which meant that some of their fund managers had to expand their capabilities to be aligned with their insurer clients.

For instance, the International Financial Reporting Standard 17 was made effective in January 2023, which included changes to insurers' accounting models, such as ensuring that insurance contracts are consistently reported on across different jurisdictions, and that contracts are measured at current value.

The Korean Insurance Capital Standard also came into effect in January 2023, which required insurers to measure assets and liabilities at market value and allowed risk to be measured using shock scenarios. The Hong Kong Risk-Based Capital framework will come into force in the second half of 2024, and introduces new requirements such as governance and controls on risk and solvency assessments.

The changes are not unlike the move towards the Solvency II capital rules for insurers in the U.K., where LGIM's Mora was based when the rules were put in place.

“It affected everything — the insurer and the asset manager working in partnership from systems to reporting through to the way we think about particularly fixed-income investing and private asset investing,” she said.

Fixed-income portfolio managers, for example, could no longer think about investing from a typical fixed-income strategy perspective, she said. “They have to think about everything they do within the context of risk-based capital and accounting regimes, and the impact of that portfolio management decision on the capital charges and the overall portfolio. And that's a completely different mindset.”