Asset management: a bellwether of the market
With underwriting returns having faced a tough few years and the capital markets creating their own unique challenges, establishing a sound investment strategy is a matter of urgency for global re/insurers. Many are turning to third party asset managers to help them navigate their way through the troubled waters and they don’t come any bigger than J.P. Morgan. Speaking with Matthew Malloy, head of global insurance solutions, at the firm, it is clear that clients are increasingly seeking out bespoke asset management solutions: strategies that consider the full gamut of available investment options.
When it comes to investments, re/insurers are not altogether different from other institutions in their approach to portfolio management. Their starting point is a portfolio “thoughtfully and conservatively invested, one that is predominantly liquid and supportive of their liability structure”, said Malloy. Reinsurers have increasingly focused on total rate of return versus book yield, he said, which increases the range of suitable investment strategies.
Crisis stations
The financial crisis has prompted some changes in the way that re/ insurers have dealt with their investments, but there has been no dramatic shift, said Malloy. The risk of inflation had prompted some re/insurers to shorten the duration of their portfolios, and increase their exposure to “floating rate debt, real assets and other inflationsensitive type products to mitigate inflation risk”, but over the past several months, inflation risk has subsided. Malloy said that J.P. Morgan’s view was that the threat posed by inflation “remains a longer-term consideration, with insurers focusing on generating yield and income in the near-to-intermediate term”.
Although inflation risk has receded in the near term, issues in Europe rumble on. Malloy said that the financial crisis has “created substantial complications to the financial system in Europe. Peripheral sovereign debt and exposure to European financial institutions have presented considerable challenges” to investors, although some of this has been addressed through active portfolio management. Concurrent with the ongoing market crisis is the increasingly proscriptive nature of regulatory measures such as Basel III and Solvency II, said Malloy, “which has placed, or will place, fairly dramatic constraints on the way that banks and re/insurers manage their balance sheets”.
“The combination of a market crisis and rising regulation has nearly frozen activity in Europe,” he said, but it is also creating opportunities. “With the banks de-leveraging and divesting themselves of certain asset types, there are opportunities for re/ insurers to step in and be a provider of capital, in some instances.” It is in considering such asset classes that the industry can potentially benefit from the crisis.
Asked whether the sovereign debt crisis, coupled with regulatory measures that have required, or will require, financial institutions to shift their investment strategies could potentially create a systemic crisis, Malloy said that it might. “A lot of the stimulus and other policy measures have had the desired effect of pushing investors into riskier asset classes and re-inflated markets. That said, we do believe we are in an environment where traditional asset classes cannot be the only way institutions think about the way they invest.” He included re/insurers in this category as they look to generate yield and income and increase diversification in their portfolios in the face of challenging conditions.
Investment strategies
Conversations with clients remain focused on generating high and stable income, said Malloy, with public companies “very much focused on maintaining portfolio yield”—no easy feat in today’s troubled investment environment. He said that a recovering global economy provides opportunities to pick up yield in various asset classes, but that “such investments come with varying levels of risk and capital intensity”.
Addressing the potential of specific investment strategies, Malloy said that J.P. Morgan sees a number of areas where re/insurers can enhance their portfolios. And with the firm a “bellwether for activity in the market”—holding as it does a large and diverse portfolio to the tune of $1.3 trillion of assets under management (as of June 30, 2012)—its insights can prove invaluable.
Malloy’s team has explored a number of avenues with re/insurance clients. One of the areas in which the firm has been most active is in private market credit, particularly mezzanine debt and senior direct lending. He said that reduced capacity in syndicated credit markets has created opportunities for investors, adding that the area has been a good fit for re/insurers. Senior direct lending also provided opportunities as regional banks that had traditionally provided finance to middle market companies have pulled back in the wake of the financial crisis and greater regulation.
"With the banks de-leveraging and divesting themselves of certain asset types, there are opportunities for re/insurers to step in and be a provider of captial."
J.P. Morgan has also seen “decent risk adjusted returns on high yield debt and leveraged loans. In the corporate US—where balance sheets are strong—there are opportunities to pursue liquid equity strategies that offer compelling dividend yields relative to other strategies”. J.P. Morgan has also seen strong interest in emerging market debt, with sovereign and corporate offering higher yields than those in developed markets, improving fiscal positions and growth outlooks that outstrip European and North American markets. They offer “attractive riskadjusted returns and can form a valuable part of a re/insurer’s longterm strategic asset allocation”. He also highlighted opportunities in project finance and infrastructure debt, areas that the banks have been pressured to divest, largely as a result of Basel III.
Finally, he pointed to opportunities in the alternative investment space—surplus capital placed with hedge and private equity funds. Malloy said that such alternative strategies “tend to be focused on customised portfolios that have lower correlation to a re/insurance company’s liabilities or general account structure”.
Industry expertise
How should clients address the question of which asset manager to opt for, particularly in a crowded field? Malloy said that there are two fundamental ways to address it: the first is for re/insurers to determine the benefits of a specific approach to their investment strategy and to find one, or a few, best-in-class investment managers to implement that particular approach.
The second, and increasingly popular, option is to work with managers that possess a deep understanding of the re/insurance business. This is where Malloy and his team at J.P. Morgan focus their efforts. As he explained, his global insurance team draws together professionals with a strong technical understanding of the re/insurance business, “speak its language and understand its objectives and constraints”. The team consists of portfolio managers, actuaries, strategists and client-advisers who understand the nuances of re/insurance and can manage clients’ investment strategies and portfolios accordingly. “In our view this is hugely beneficial to our clients and is what it takes to be a successful asset manager to the re/insurance industry.”
Toughing it out
Addressing the state of the global economy and its likely heading, Malloy said that J.P. Morgan’s “core scenario is that we will continue to muddle through”. He added that “the downside risk of a major negative outcome for the markets has lessened, but there has been no real revision to the upside case”—which remains decidedly limited. The actions of governments and central banks globally will create challenging investment conditions for insurers for the foreseeable future, he said, concluding that the firm expects that there could be another “two years or more of low rates and growth, challenging fiscal dynamics in developed markets and a slowdown in developing regions”. It would seem that in such a troubled investment environment, picking the right asset management team has indeed become all the more essential.
Matthew Malloy is head of global insurance solutions at J.P. Morgan Asset Management. He can be contacted at: matthew.malloy@jpmorgan.com
