Times are tough for insurance asset management, with the average value of portfolio yields coming down year after year, leaving performance largely dependent on carry levels that are set over time.
We believe a solution to consider is to look beyond traditional “Buy and Hold”1 to “Buy and Maintain” strategies that are designed to provide a dynamic approach, allowing the portfolio to cushion inevitable declines in yield values over time.
To illustrate how Buy and Maintain2 works and characteristics to consider, we identify five sources of value-add:
1. Asset allocation
Asset allocation is always the main portfolio driver, even in a low interest rate environment. Well-structured guidelines allow the portfolio to take advantage of different market configurations.
2. Diversification
Implement with traditional geographical/sector diversification with diversified investment strategies adding non-euro securities (hedged by currency swaps), crossover issuers (benefiting from a positive outlook), unrated securities and/or private placements.
3. Timing
Successfully manage the initial ramp-up and over the life of the strategy. For insurance portfolios, to optimise the portfolio yield, we are reactive in periods of correction. We calculate that optimisation techniques can potentially lock in an additional 20bps over a period of two years.
4. Risk management
A conviction-based approach allows for securities to be sold before maturity. During periods of credit market stress, a well-documented credit view can be extremely useful in deciding whether to reduce portfolio risk or to lock in additional yield.
5. Arbitrage
Buy and Maintain is managed with an opportunistic approach. When rates are low, the team implements arbitrage strategies between asset classes, sectors, maturity segments (curve arbitrage, etc) and primary market vs secondary markets.
Decisions will always be dependent on the agreed guidelines, ensuring the long-term investment horizon of the portfolio. The aim is to avoid short-term tactical position-taking.
To illustrate value-add from arbitrage, we calculate that during a period of two years (2017-18), contribution of adding duration as an arbitrage strategy was equivalent to 26bps in yield per year of duration. The additional yield acquired was much higher than the market average of 12bps (using the 7-9-year euro swap curve as a benchmark) over the same period. This contribution is higher than the annual investment of inflows from coupon payouts, redemptions and net new business.
Conclusion
At Ostrum, we believe that insurance bond asset management deserves to be more than passive or inactive. We believe insurers can consider a more dynamic approach to lock in spread levels. We believe Buy and Maintain strategies are well suited to sit alongside traditional and cautious long-term investment strategies.
Ostrum AM manages €170 billion in insurance assets, comprised of more than 80 bond portfolios managed for 25 clients2.
1 – Buy and Hold is an investment strategy where the investor purchases debt securities and keeps them in the portfolio until maturity.
2 – The Buy and Maintain strategy is subject to the risk of capital loss (default risk), interest rate risk and currency risk.
3 – Source: Ostrum Asset Management at December 31, 2018.
Written on May 3 2019. This document is intended for professional clients in accordance with MIFID. None of the information contained in this document should be interpreted as having any contractual value. Ostrum AM will not be held responsible for any decision taken or not taken on the basis of the information contained in this document, nor in the use that a third party might make of the information. Figures mentioned refer to previous years. Past performance does not guarantee future results. Any reference to a ranking, a rating or an award provides no guarantee for future performance and is not constant over time. The analyses, opinions, and certain of the investment themes and processes referenced herein represent the views of the portfolio manager(s) as of the date indicated. These, as well as the portfolio holdings and characteristics shown, are subject to change.
By Farhat Selmi, Head of Buy and Maintain Strategy in Insurance Portfolios, Ostrum AM
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