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Tom Collier[/caption]
Solvency II regulations are set in stone to start from January 2016, and this combined with a difficult investment environment throughout the region caused by low interest rates means that insurers and pension funds have to adapt their investment strategies now in order to remain profitable.
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Eugene Dimitriou[/caption]
Ahead of the 3rd Annual Nordic Asset Allocation under Solvency II conference, we spoke with Eugene Dimitriou, Senior Vice President, Account Manager, Insurance and Tom Collier, Senior Vice President, Product Manager, Alternatives at PIMCO about designing profitable and compliant investment strategies for the Nordic insurance and pension fund industries.
What trends are you seeing in the Nordic insurance market leading up to Solvency II?
The dominant theme for European insurance companies is the low-yield environment, in particular the difficulties inherent in meeting minimum returns for policyholders. As a result, insurers are seeking alternative ways of increasing yield, ideally with a low correlation to the existing asset portfolio. Solvency II provides a new lens through which insurers in Europe need to quantify the impact of low returns. As all Nordic countries (apart from Finland) have not adopted the euro, currency matching represents an additional complication as Nordic insurers seek to match investments with local currency liabilities.
How could alternatives fit into an insurer’s broader investment portfolio?
Alternative investments are typically marketed as either offering higher returns or diversification benefits, and often both. Opportunistic or private equity-style strategies generally assume credit or equity risk, while core real estate and other forms of real assets may possess significant interest rate risk, given the sensitivity of long-dated cash flows to discount rates. While such strategies may still offer some diversification benefits, PIMCO primarily manages opportunistic strategies, where we believe that we are able to deliver returns that are sufficiently high to adequately compensate for the liquidity foregone. To the extent that Nordic insurers have the flexibility to deploy risk capital, investing in such opportunistic strategies for higher returns may enhance their return on equity.
We believe that hedge funds should offer diversification benefits versus traditional asset classes, while using their flexibility to potentially deliver strong, risk-adjusted returns. In our view, where hedge funds can potentially deliver equity-type returns with bond-type volatility and a low correlation to bonds and equities, we believe such investments ought to merit consideration for most insurers’ asset portfolios. Given historically low yields and high interest rate duration, hedge fund strategies are increasingly being used as substitutes for fixed income beta.
In the current environment, what opportunities exist for insurers to invest in alternatives?
Within opportunistic strategies, PIMCO currently sees two opportunities that we believe are far less crowded and may offer insurers compelling prospects for returns. The first opportunity is to transition credit risk into a form and marketplace where the supply and demand are most favourable. For example, credit risk can sometimes be assumed in private markets and can be securitised to be sold into public markets to capture an illiquidity premium. Alternatively, legacy structured products can be collapsed to obtain a direct exposure to the underlying loans, capturing a complexity premium. Some of these situations offer attractive internal rates of return (IRRs), but may have relatively short life spans, making them less appealing to traditional private equity funds. The second opportunity is corporate distressed assets, specifically in the mid-market, where we have been monitoring the deterioration in underwriting standards closely. Original lenders in that space are unlikely to want to lead restructurings, but the publicly listed private equity managers are raising very large distressed funds that may struggle to invest meaningfully in the mid-market.
On the hedge fund side, the model of allocating capital to a large number of traders is being challenged. Tight stop-losses and the challenge of creating coherent portfolio diversification under such a model could inhibit the ability to hold, and be rewarded for, a fundamental view. Although many of the big macroeconomic themes in 2014 were consensual, such as monetary policy divergence, emerging market differentiation and U.S. dollar appreciation, there was scope to profit through trade and portfolio construction. At a more idiosyncratic level, focusing on areas where investment banks are exiting businesses or are no longer policing relative mispricings (such as commodity markets, sub-investment-grade capital structures and options markets) continue to be compelling.
In your view, how could an effective alternatives portfolio be constructed?
When it comes to opportunistic strategies, PIMCO is a strong advocate of broad and flexible mandates that mitigate the pressure to deploy capital in any specific sector. Broad mandates are often more difficult to market, as allocators naturally want to know where their capital is going to be invested; however, provided the investment manager has the requisite breadth and depth of resources, such flexibility is essential to ensure a truly opportunity-driven investment approach.
The decision to allocate to hedge funds is often motivated by the portfolio diversification benefits derived from returns that are dominated by alpha; yet that characteristic is sometimes under-emphasised in selecting an investment manager, where ranking by total return (alpha and beta) often proves irresistible. In fact, our own analysis suggests that the manner in which alpha has been earned over time is a better predictor of value added than the simple magnitude of returns. The institutional investors, who today account for the majority of hedge fund capital, mostly understand this. However, the task of selecting investment managers who are able to consistently deliver significant alpha remains challenging. As a result, those investors are increasingly choosing to work with institutional-quality platforms, who hire managers, design hedge fund strategies and monitor risk, to provide alpha-dominated solutions.
What would you like to achieve by attending the 3rd Annual Nordic Asset Allocation under Solvency II Conference?
PIMCO seeks to better understand the constraints of Nordic insurers and their investment strategies. Further, we seek to increase our profile among Nordic insurers with respect to both alternative investment strategies as well as more traditional ones.
About the speakers:
Mr. Dimitriou is a senior vice president and account manager within PIMCO’s financial institutions group in the London office, focusing on business development and client servicing. As a member of PIMCO’s insurance team, he leads PIMCO’s Solvency II working group in preparation for the new regulations. Prior to joining PIMCO in 2013, he was a managing director in Royal Bank of Canada’s financial institutions group, advising insurance companies on asset/liability management, structured finance, risk management and investment strategy. Mr. Dimitriou has also held senior positions at Royal Bank of Scotland, Morgan Stanley and William Mercer, an actuarial consulting firm. He has 20 years of investment experience and holds an MBA from the Stern School of Business at New York University as well as an undergraduate degree from the University of Waterloo in Waterloo, Canada. He is a Fellow of the Society of Actuaries (FSA).
Mr. Collier is a senior vice president and product manager in the London office, responsible for alternative investment strategies. Prior to joining PIMCO in 2012, he was a director at HSBC, evaluating alternative investment funds and strategies. He performed a similar function at a subsidiary of Bank of New York Mellon, where he was also a member of the investment committee and held responsibility for client reporting. He began his career at Barclays. He has 17 years of investment and financial services experience and holds an undergraduate degree from University College London.
About the event
This marcus evans conference will demonstrate practical and strategic solutions for increasing investment returns that are efficient with both regulations and a difficult investment environment. At the same time, it will reveal the requirements of insurers and pension funds for asset managers which will help them to adapt and become a more attractive proposition to manage insurance and pension assets.
The 3rd Annual Nordic Asset Allocation under Solvency II Conference will take place from the 5th until the 6th of February 2015 in Stockholm, Sweden.
For more information about the event, please click here or contact
Constandinos Vinall
T: +357 22849 380
E: [email protected]
For professional use only
This presentation contains the current opinions of the manager and such opinions are subject to change without notice. This presentation has been distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this presentation may be reproduced in any form, or referred to in any other publication, without express written permission.
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