For pension funds that have not yet reached self-sufficiency and for insurance companies that leverage, squeeze and manage their balance sheet, capturing a premium above government bonds within a closely monitored asset-liability-monitoring framework is a necessity.
It may not be surprising to see pension funds and insurers looking for similar income-generating investment opportunities and strategic allocations; both are long-term institutional investors, and the overarching objective for both is to ensure timely settlement of liabilities.
Regulation dictates that insurance companies can never have a deficit and have to hold capital for every unit of risk they take.
Despite a low-yield environment, insurers’ allocation to infrastructure represents less than 1 per cent of the current total allocation for large insurers globally and close to none for mid-sized insurers.
Likewise, pension funds in the UK – though not motivated by regulation in exactly the same way – are moving towards low-risk portfolios, for at least a portion of their holdings.
As such, a source of risk that offers some premium above government bonds – in other words rewarded risk – could be worth considering as part of an investment portfolio for both insurance companies and pension funds.
This is all the more advantageous when liabilities extend throughout the full time spectrum, allowing investors to take advantage of an illiquidity premium as well.
Insurers and schemes look for real assets
Although much depends on an investor’s risk-and-return objectives, liability frameworks, existing portfolios, liquidity needs and constraints, duration requirements etc, given the above context it may not be surprising to see pension funds and insurers looking for similar income-generating investment opportunities and strategic allocations.
In their search for higher yield and regular cash flow, institutional investors in the UK have already looked to diversify their asset allocation, and this trend is expected to continue.
Although infrastructure is one such avenue of investment, other real-asset strategies, such as direct lending or real estate investment trusts, also appear well placed to satisfy investor demand for higher yield, regular long-term income and duration.
Real assets have unique characteristics that are very appealing to long-term investors. They can offer, among other things, a long-term cash flow, duration and inflation protection and potentially high risk-adjusted returns, given the relative inefficiencies and limited transparency in the market if such limited information can be accessed cheaply.
Range of deals
Real assets, especially those on the private side, are diverse in nature. Investments in these assets are characteristically time-consuming, expensive and intensive in terms of due diligence.
This is why, despite a low-yield environment, insurers’ allocation to infrastructure represents less than 1 per cent of the current total allocation for large insurers globally and close to none for mid-sized insurers.
Increased investor attention towards real assets, for the reasons outlined above, will see further efficiencies coming into the investment process.
A more diverse range of deals should also come through as the market deepens. A recent favourable change in the Solvency II treatment of infrastructure assets for insurers should help this process as well.
But given that real assets are not available on the open market with the exception of listed REITs, it is worthwhile for pension funds and insurers to look at real assets through a wider lens, taking a dynamic and agile approach towards investing in the universe of real assets as and when the market cycle, liquidity and investor needs together make the investment opportunity attractive.
Elodie Laugel is deputy head of Axa Investment Managers’ institutional client group
