Mr Patrice Conxicoeur of HSBC Global Asset Management (Japan) K.K. introduces the incentives of investing in equities which were once regarded as pariah investments.
Insurers face a perfect storm of solvency and accountancy reforms which, through their focus on marking prices to market and Value at Risk (VaR), increase the volatility of financial results, turn market volatility into public enemy number one, and are notoriously equity un-friendly in capital cost terms.
With those reforms in sight and after multiple bouts of extreme volatility and price falls in the last 20 years, and with the mother of all bond bull markets as a backdrop, it is no wonder that insurance equity holdings stood barely above zero at the end of the last decade.
Equities were never investments to be avoided
But this bond bull market is probably over, even if Asian investors can still expect to benefit from a few rounds of monetary easing in some regional bond markets. Two realities have also sunk in: firstly, nearly all equity markets yield more than local treasuries, often by a wide margin. Secondly, at very low levels of yields, long-dated fixed income instruments can display equity-like volatility, and yet offer next to no prospective total return. So have equities gone from pariah investments to only game in town?
As ever the reality is a little more complex, especially in Asia. Indeed, a granular examination of the Asian insurance investment reality shows that equities were never quite off the menu, thanks to a strange combination of lagging regulations, and incomplete markets.
Indeed, the transition from reserving to solvency regimes is far from over, with only three exceptions in the region, and in bond markets where very long-dated bonds are not available to match similarly dated liabilities, equities can be a proxy (better an imperfect one than none).
Furthermore, while high regulatory capital costs can act as a deterrent to invest in equities, in an attractive industry such as insurance, the big issue is not as much capital costs as return on said capital, regulatory adjusted if needed.
Different solvency regimes treat equities and other asset classes similarly
We can brush aside the fact that all multinational players operate under at least two different solvency regimes wherever they are, save on home ground. This is because while different solvency regimes have very important differences, they are all broadly aligned in their treatment of equities vs other assets classes.
We have documented this in our research, while looking at forward-looking returns on solvency capital requirements under various regimes: while calculations vary widely, for the most part the pecking order of asset classes remains coherent across solvency regimes.
Our main finding with this research was thus deceptively simple: if the prospective equity investment case holds, it is likely to still be the case under RBC (Risk-Based Capital) Solvency II and other regimes of a similar vein.
In other words, solvency regulations may raise the investment return threshold for equities, but the logic still holds. It is also important to highlight that for all their differences, solvency regimes are unified on one point: the capital cost of investment in equities is never differentiated by investment style, nor risk level, save some (rather arbitrary) geographical distinctions. In other words, whether the insurer is investing in equities with active, passive or alternative beta strategies, the capital cost is the same.
Deciding the strategy
The debate can thus focus squarely on the facts of investment case: what prospective returns, for what end, within which risk appetite, within what investment strategy and implementation plan?
As ever with such questions, clarity of objectives and quality of execution are key, but do not favour a particular idea or style. For instance, passive investments can be suitable for an insurer with little governance and investment resources, but this then focuses the debate on the suitability of the replicated index vs liabilities and risk appetite. Often, enhanced indexing or smart beta will sound like a better idea, but again with exposure to specific risk factors which must be understood.
Ditto with high dividend and low volatility investing, which has proved popular in insurance circles, for good reasons overall, but also, we suspect, more to the pleasure of accountants than Chief Investment Officers in the case of high dividends. In short, buyer beware, especially with good ideas, as they can lead to crowded trades or myopic investment strategies through excessive focus on a specific factor.
Equities still attractive
Overall therefore, rumours of the death of equity investment proved to be greatly exaggerated, as impending or recent regulatory changes did not manage to obfuscate their attractiveness. However their undeniable attractiveness vs bonds removes none of the complexities of equity investing. And of course, our mission is to assist insurance investment teams to navigate those treacherous waters.
Mr Patrice Conxicoeur is CEO, HSBC Global Asset Management (Japan) K.K.
This article is published for information only and opinions expressed herein should not be considered as investment recommendations.