When should insurers invest in global credit?
Samu Anttila, Chief Investment Officer at LAHITAPIOLA discusses how to weigh up the the diversification benefits of global credit versus the costs of currency hedging
Insurance Investorposted on Monday, June 15, 2020
Insurance Investor: How should insurers approach the transition to global credit? When is a good time?
Samu Anttila: In Finland we operate in the Eurozone, so we are more flexible in investing within Europe.
The question is about liquidity, so how liquid we feel the market is. And when we go outside the Eurozone there are quite a lot of questions that need to be asked such as what the underlying liquidity in a time of crisis is and how much illiquidity can you tolerate?
"The question is about liquidity, so how liquid we feel the market is"
Because in our portfolio, we do have a lot of illiquid investments like real estate, private equity and direct loans etc. I don’t know if there is an answer as to when is a good time.
It may be about taking a partial approach. So, rather than going with the large banks, you go for some diversification timing-wise.
You can then increase your position bit by bit when you see that it fits. But it depends on whether you feel you can get some additional diversification from global credit.
Insurance Investor: What is your outlook on risk for investment grade credit? How concerned should insurers be about volatility and potential defaults?
Samu: I am concerned as we have seen all-time low default rates, which is a very big risk.
The yields are quite low at the moment so there is not much room for additional or bigger default rates.
Insurance Investor: What are the costs of currency hedging when investing in dollar onds so as to not be exposed to currency volatility?
Samu: It is quite high at the moment as, if you look at the yield curve differences between the dollar in the US and the Eurozone, this is essentially the difference that you will have to pay if you want to hedge out the currency risk, which I believe is around one per cent.
Insurance Investor: What are the additional capital requirements that you get from FX and currency risks from a Solvency II perspective?
Samu: We are using standard ones for this so that basically there is some additional capital requirement for the FX risk.
It is more about analysing whether you can tolerate the currency risk and not to hedge it, or you are unable to tolerate it and therefore, take the currency hedging costs immediately.
We are not hedging that much at the moment, so we leave the FX risk open. But that is a subject that requires further analysis on our part.
Insurance Investor: you are not hedging so what is your approach when deciding to invest in dollar bonds and Euro bonds?
Samu: It is more a question of diversification. So, it does depend on the situation and what you want to achieve.
If, for instance, you isolate the spread risk and want to achieve some additional diversification in the spread rather than just investing purely in the European markets, you will expand your investment capabilities to cover dollar-based spreads as well.
Here you might achieve some diversification which might be good or bad, so you have to analyse case by case to see if it makes sense to do.
"You have to think about what you want to achieve in the spreads"
On top of this, you must make the decision as to whether you just hedge the underlying currency risk.
You have to think about what you want to achieve in the spreads. If there is some additional diversification that you might get then the next question will then be whether to hedge and change the underlying curves, which might generate some additional return capabilities.
My feeling is that it might make sense to invest into a lower- based market and even hedge them so that you can still get some additional diversification in the spreads.
This article originally appeared in Asset Management for European Insurers - A bespoke Report with Wells Fargo Asset Management. You can download the full report here.