In the current low-yield environment, institutional investors will increasingly be forced to take on more risk and turn to less familiar asset classes, something which should heighten the attraction to insurance-linked investments and ILS, according to Twelve Capital.
In this low-yield world investors should look to insurance and reinsurance as an asset class that can drive returns, Twelve Capital said at its recent investor day, as the risk premiums available on conventional assets continue to dwindle.
Insurance is the last “great opportunity” for institutional investors, according to Twelve Capital. Insurance, reinsurance and ILS provides an asset class which combines well-regulated entities and where understanding of the pricing of risk is more than adequate, the manager said.
That is certainly an attraction for investors, alongside the ability to access returns that are relatively uncorrelated with broader economic factors, at least within insurance-linked securities (ILS) and investment assets such as catastrophe bonds.
Institutional investors will need to fundamentally change the way they allocate capital, according to Twelve, as the returns on traditional assets are no longer providing a sufficient return to enable them to meet their targets.
This will result in a continued push into alternatives and less familiar asset classes, in order to continue to make the returns they require as conventional asset classes continue to see yields decline.
“Investors can’t ride the wave of guaranteed returns anymore,” Urs Ramseier, Chairman and Chief Investment Officer at Twelve Capital commented.
“As investors are forced to diversify into previously unfamiliar asset classes, risk premiums will come down, meaning there is less room for error in the investment process. The key success factor moving forward in financial markets will be to have a fundamental understanding and thorough evaluation of the investments people are making,” Ramseier continued.
At the event it was highlighted that insurance-linked corporate bonds carry a much higher yield than typical corporate bond comparisons, despite the softening and decline in their yields.
Ramseier explained; “We believe the spread tightening in the insurance bonds market will continue, because investors are being forced to take on more risk in the search for higher returns and yields, which will lead to significant capital gains on top of the coupon payments for these types of bonds.”
Another opportunity that presents itself to investors is investing in insurance company debt, something that Twelve Capital specialises in through the provision of private debt to smaller insurance or reinsurance companies to help them meet solvency capital requirements.
“Given that these companies do not have access to capital markets, they need more regulatory capital. We provide such capital to these smaller insurance companies and our private debt strategy is producing extra yield,” Ramseier explained.
Ramseier also discussed the ability of ILS to provide a low volatility addition to an institutional investors portfolio. Despite the fact catastrophic events can be volatile, as a diversified investment ILS and catastrophe bonds can provide attractive returns over the longer-term, while displaying low volatility and low correlation with wider financial market factors.
“We believe that investing in ILS makes a lot of sense in the context of an institutional investment portfolio to reduce volatility, which will significantly increase in the next 2-3 years in financial markets,” he said.
Even equities can be attractive in insurance and reinsurance, Ramseier explained, with re/insurers displaying some of the highest dividend yields across the equity markets. Twelve Capital believes that insurers that require less capital under Solvency II regulations could increase their dividends, making this a good time to invest.
Ramseier explained; “We expect dividend payments to increase among the big insurance companies and for dividend yields to go up. Investing in dividend stocks in the insurance sector is very attractive.”
“We are seeing a major shift in financial markets as the risk premium on conventional assets has narrowed significantly,” Ramseier summed up. “Currently, investments in the insurance space are not being actively managed by mainstream managers, and the wider market knows very little about the sector. This is a great opportunity for institutional investors to fulfil the promises of certain returns they have made to their clients.”