5 min read 21 Sep 21
Insurer allocations to private markets are definitely on the rise. The low yield environment is encouraging investors to look outside of traditional core fixed income allocations (investment-grade corporate credit and government bonds) and at more complex private asset opportunities, to improve their investment portfolio return.
We see increased interest in private markets as a long-term structural shift, rather than a stop gap until public bond markets offer better value. The pricing of some private assets tends to move in line with corporate and government bonds, to some degree and albeit with a time lag, so if liquid bond market yields rise, then we would expect private markets to move that way in order to continue to attract the capital that is needed to meet demand from borrowers for private financing solutions.
This isn’t just a return trade though – insurers are also considering the potential diversification benefits on offer and the potential for better risk mitigation through structures that give the benefit of security over (and recourse to) hard assets or enhanced financial covenants when investing in the private markets.
Yes, we think this is an important consideration for managers and investors alike.
It’s important to remember that the private marketplace is a different beast to the highly-commoditised and scalable world of public fixed income investing that has historically dominated insurers’ investment thinking. Once the decision to enter the private markets is made, we tend to see insurers focusing on one asset class at a time. Given regulatory constraints and broadly similar business needs, insurance assets tend to flow to quite narrow parts of the private asset universe. The supply in these “insurance friendly” assets will naturally be constrained.
A single insurer will rarely be the only one to spot opportunities in new private asset classes, and insurers need to be particularly conscious of herd behaviour and the potential for yield compression or weakened debt covenants. The risk of assets becoming ‘popular’ is particularly high given the extended governance timelines that insurers typically operate under.
Building a framework that gives investors access to the private markets in a scalable, deployable and optimised manner should be a major consideration for insurance investors.
We believe that investors generally have two options:
It is important to stress that there is absolutely still a place for single asset class allocations, however we advocate that this should not be the only route to market for insurers.
Core credit mandates that invest in publicly-traded markets are not subdivided by sector. Investors do not run separate sleeves for utilities, retail, and financials exposures, but instead look for their asset managers to find opportunities across the bond markets and select the investments offering the most compelling value. A similar approach can also be taken when allocating to private markets, and could allow investors to harness the full potential of markets over the long term.
At M&G Investments, we are working with our clients to build flexible, and suitably risk-constrained, multi asset mandates that are designed to look holistically across the entire private debt universe and invest in areas of the market which offer good value. By doing this, we look to build greater diversification into portfolios as well as increasing the chances for quicker capital deployment and meeting overall portfolio outcomes. Further, we aim to limit the risk of the market trading away.
Regardless of the preferred route to market, we would encourage investors to keep the focus on why private markets were initially included in their investment portfolio – to improve yields versus public markets, add diversification of risk, and introduce the potential for better downside protections. If these potential benefits diminish due to weakening market dynamics, it is important for investors to work with their managers to look for alternative options to ensure their private asset allocations are optimised.
Private debt markets, on the whole, are attractive under the Solvency II framework with a typical private debt mandate equivalent to ‘BBB-rated’ public debt from a risk and ratings perspective (although there are exceptions). When building multi asset private debt portfolios, we work with our insurance clients to arrive at a solvency constraint in line with their capital coverage requirements.
It is important to partner with an asset manager who has the capability to internally rate assets under an approved ratings methodology framework. The bond markets are by no means risk-free and the private marketplace is no different. It is critical that investors are able to quantify the risks they are taking beyond the ‘unrated’ mantle that Solvency II attributes to these assets.
The value of investments will fluctuate, which will cause prices to fall as well as rise and investors may not get back the original amount they invested. Past performance is not a guide to future performance. The views expressed in this document should not be taken as a recommendation, advice or forecast.