Insurers weigh benefits of multi-asset funds

Asset managers are promising insurance companies that invest in multi-asset funds an equity-like return for a fraction of the capital, but is this the best way forward in the hunt for yield?

It sounds too good to be true – asset managers are promising insurance companies that invest in multi-asset funds an equity-like return for a fraction of the capital requirement. As the shrewd management of capital becomes increasingly important in investment decision-making, firms are taking note. But are multi-asset funds the best way forward in the hunt for yield?    

The pitch from asset managers is that volatility is much lower for their multi-asset offerings than for single-asset portfolios producing similar returns, which is an attractive proposition for insurers caught between ultra-low interest rates on the one hand and punitive capital charges under Solvency II on the other. Ten-year German Bund yields, for example, have fallen from 1.93% to 0.86% since January, while the capital charge for equity under Solvency II is 39% or higher.

Bruce Porteous, investment solutions director at Standard Life Investments, told delegates at a recent conference they could gain equity-like returns for a quarter of the cost of capital if they invest in a suitably structured multi-asset fund. Pension schemes have been the biggest buyers of multi-asset funds so far, he says, but he expects insurers to catch on to the idea soon. “With the problem of low interest rates and scarce capital, insurance companies are going to be looking to generate yield in a very capital-efficient way,” he says.

For insurers browsing the products on offer there are some eye-catching numbers.

Standard Life’s most successful fund, and the largest in the market, delivered a rolling three-year return of 8.37% at the end of August. The Global Absolute Return Strategies Fund (Gars) has a broad investment remit and targets a return equivalent to six-month Libor plus 5% per year, gross of fees. The fund uses a combination of traditional assets and derivatives strategies, resulting in a highly diversified portfolio.

Indexed retail UK Gars price versus indexed six month Libor (GBP)

 

Monthly data from July 2007 to April 2014 shows the annualised volatility of Gars is 5.6% while that of global equities is 13.3%. This shows Gars has roughly one-third the volatility of an equity portfolio, yet it can offer similar returns, says Porteous.

Elsewhere, Aviva Investors offers five variants of multi-asset funds, tailored to varying risk appetites. For the year ending September 30, the asset manager’s Multi-asset Fund I, the least risky, delivered a return of 5.8%, compared with 10.6% for Multi-asset Fund V, the most risky. While the former is focused on international bonds, making up 26.7% of asset allocation, the latter is dominated by international equities at 94.4%.

The potential attraction for insurers, however, goes beyond high returns. Solvency II is increasing the influence of capital management on investment decisions. Therefore, if insurers can demonstrate they are exposed to risks that are weakly or negatively correlated, they will gain under the directive’s so-called diversification benefit from a reduction in the level of capital they are required to hold. A multi-asset fund might also be able to invest in a more geographically diverse pool of assets than would be typical for an insurer, Porteous explains.

“Based on what we have seen, multi-asset funds can generate equity-like returns, and when you look through and stress the individual assets according to Solvency II, [the fund’s] volatility and capital requirement can be much lower than [for] equity.”

At Axa Investment Management, the idea has been taken a step further through its SolEx fund, which provides European equity exposure while hedging against any sudden market downturn. The multi-asset team uses equity put options and total return swaps as a tactical overlay on an equity portfolio, thereby reducing the solvency capital requirement (SCR) for the fund.

Using the standard formula for calculation, the SolEx fund can reduce the SCR from 39% or more (for pure equity) to between 15% and 25%. Amaury Boyenval, insurance solutions strategist at Axa Investment Management, explains: "When the total consumption of SCR (equity investment and overlay) is above 25%, we will adapt the [derivatives] overlay to keep the SCR below that. From what I can see, we are the only asset manager proposing a strict maximum on SCR.”

The past five years have seen an ideal environment for multi-asset funds, according to Gavin Counsell, senior multi-asset fund manager at Aviva Investors, as managers have benefitted from rallies in the bond and equity markets since the financial crisis of 2008. He points to the possibility of rising interest rates in the UK and US as an example of the current uncertainty firms are facing, and proposes multi-asset funds could help to dampen the volatility associated with such an event.

In particular, firms are concerned about the impact of divergent monetary policy on international interest rates, he argues, making a geographically diverse fund attractive. Aviva Investors’ Multi-asset Fund V, as one example, has a 7.8% allocation of assets in emerging Asia, 7.4% in Japan, 19.1% in developed Europe and 52.2% in the US. 

Insurers are split on the merits of the multi-asset fund approach. Nikhil Srinivasan, group chief investment officer at Generali, is an enthusiast. “The divergence in monetary policies across the globe is going to open up opportunities for unconstrained funds active across a variety of asset classes,” he says. “Multi-asset funds are the sort of capital market player willing and able to benefit from such a scenario. Long-only traditional funds with strict mandates are not suited to navigating the financial markets landscape that investors are going to face in 2015 and beyond.”

Others are less convinced, questioning the complexity of multi-asset funds and saying they add additional costs without superior results.

Hansjörg Germann, head of strategy development in Zurich Insurance Group’s investment management unit, says: “Investing in funds, which themselves invest in different asset classes or asset types, makes the steering of intended exposures more difficult and adds another cost layer.”

If an insurer uses several multi-asset funds, this introduces the possibility of offsetting exposure across them, he says. For example, one fund might be overweight in equities relative to bonds, while another may be positioned the other way around. “That would only create transaction costs at the consolidated level without a benefit.”

Many of the largest insurance companies, including Zurich, develop their own in-house mix of assets similar to that of a multi-asset fund, Germann explains. Zurich takes the view that an insourced investment function fits its investment approach better, which is focused on asset-liability management. “Given how we invest, we are a de facto multi-asset investor, benefitting from a robust asset-class allocation process, tactical asset allocation and a wide variety of asset choices, from hedge funds to real estate,” he adds.  

Robert Groves, chief investment officer at Friends Life, is also sceptical. While he agrees multi-asset funds have fulfilled their promise to reduce volatility, he believes they have not delivered equity-like returns, making investment in long-term equity a better option.

Porteous counters that firms should not be fixated on returns, but on the risk and capital requirements instead. Insurers can have cash plus 6% returns if they want, but it will require more capital, he says. A multi-asset fund can be structured in a more capital-efficient way.

With the success of Gars delivering an average of 8.37% over the past three years, it seems likely that multi-asset funds and their managers will continue to attract interest. At the same time, the investment outlook in general is limited for insurers. Uncertainty over whether to increase yield by moving into non-traditional assets, coupled with the growing need for capital efficiency and concerns about divergent monetary policy, is causing a change in priorities. In such an environment, buying diversification off the shelf will doubtless prove an attractive option for some.