As importance of portfolio construction rises, reinsurance put in focus by KKR

Reinsurance as an asset class now deserves a place among KKR’s latest Capital Market Assumptions (CMAs), with the investment giant explaining that portfolio construction and private market assets are rising in importance, as a broad beta approach to investing is less appropriate at this stage of the economic, financial and capital market cycle.

“Expected returns are still moderately attractive, but they are becoming harder to capture across most asset classes,” Henry McVey, CIO of KKR’s Balance Sheet and Head of Global Macro and Asset Allocation (GMAA) writes in a new outlook report.

This is because tailwinds that drove the last investment cycle, of multiple expansion, falling rates and broad market beta are expected to be less reliable going forwards, with starting valuations less forgiving and less room for rates to fall than in the past.

KKR has long had an appetite for deriving returns from insurance and reinsurance opportunities, and as an asset class, or industry capital can be deployed in, re/insurance has regularly featured in its insights.

But, as financial markets remain volatile and the tailwinds that have driven recent historical performance slow, KKR is elevating reinsurance into a more prominent position in its thought-leadership, it seems.

Reinsurance is one of five new private markets asset classes that has been added to KKR’s Capital Market Assumptions (CMAs).

The investment giant states, “Investors should treat our CMAs less as a simple ranking of asset classes and more as a framework for understanding what return streams they can access, how those exposures are structured, and where manager selection can add value.”

Return assumptions across the CMAs have been updated, to account for the changing financial conditions, and reinsurance features for the first time with a next five years return assumption of 8.7% in USD (presumably annualised).

Which stacks up very well against a range of alternative and private market assets, while of course reinsurance offers one of the least correlated opportunities, depending on the route to market used to access returns from the sector.

KKR says on the changes to its CMA listing and return assumptions, “We believe the changes reinforce our broader message that the source of returns is shifting. Broad beta can still contribute, but we think non-correlation, control, collateral, and manager selection are likely to matter more than they did in the past.”

Which is super-interesting given reinsurance as an asset class and in-particular many insurance-linked securities (ILS), including catastrophe bonds, are particularly noteworthy when it comes to their non-correlation with broader financial assets and markets, and the stable collateral supporting them that also delivers part of the total return, while manager selection in ILS is also key.

Expected returns have changed at the margin, KKR explains, which means selectivity in terms of asset classes increases in importance, so with it portfolio construction and the broad beta play should be less dominant within investors portfolios.

“This reality does not mean opportunities are absent. Rather, it means they are less obvious at the asset class level. In our view, the more important sources of return are increasingly concentrated beneath the surface, where sector, issuer, geography, collateral, and manager selection matter more. The broader message is that when expected return dispersion across asset classes is narrow but outcome dispersion within asset classes is wide, portfolio construction becomes a more important asset allocation lever,” KKR says.

In addition and this is another notable statement, given how investors can be driven to become more exploratory and open to alternative asset classes they may not have considered before, KKR says that differences beneath the surface of asset classes are becoming increasingly pronounced.

On the newly added asset classes to its CMA listing, including reinsurance, KKR states, “These asset classes can offer exposures with different roles in a portfolio, including up-front yield, collateral protection, nominal GDP linkage, inflation sensitivity, and lower correlation to public markets. Manager dispersion also remains an important consideration for investors in Private Markets, reinforcing that who implements the exposure may matter as much as the exposure itself.”

KKR has of course constructed its own reinsurance sleeve within its platform thanks to the addition of Global Atlantic and its life and annuity reinsurance sidecar structures.

KKR describes this strategy as, “Access to a corporate carve-out sleeve of insurance companies with participation in assets, including diversified investment portfolio, and liabilities, including policies.”

Which is not ILS in its most traditional form, of course, it’s a long-way from 100% natural event exposed catastrophe bonds, for example.

But it is akin to reinsurance sidecar investing, particularly where there is some tail or duration to the insurance risks underlying the structure, allowing for an asset-side play alongside insurance-linked returns.

Naturally though, the more traditional ILS and cat bond investing reduces the correlation with broader financial markets, such as equities. Where as the reinsurance strategy KKR explains with Global Atlantic is still more correlated, given the asset side and the exposure to a listed company, rather than directly to insurance risks.

There remain a diversity of options for deriving returns from insurance and reinsurance and KKR clearly continues to recognise these opportunities and now elevates reinsurance in front of its investors and clients.

In addition, the investment giant notes that asset classes like reinsurance can also deliver cash flows that compound with the economy and reprice with inflation as well, another attraction.

Private markets remain a growing component of many major investor’s portfolios and reinsurance, as well as ILS, continues to gain profile as a relevant opportunity.

Sophistication matters though and KKR highlights that, “The next phase of Private Markets performance will favor investors who can influence outcomes through governance, capital structure, pricing, operations, procurement, technology adoption, and strategic repositioning.”

That’s good advice for any large allocators looking at the ILS and reinsurance space, it’s also aligned with the strategies being embraced by many existing allocators to the asset class.

KKR’s Henry McVey has previously recommended the addition of insurance as an asset class for its diversification benefits. Now it deserves a place in the private market classes the company tracks, which can only help to further raise the profile of the asset class.