Interest rates, regulatory uncertainties call for alternative yield strategy: HSBC Asset Management

April 26 2024 by

With key first-quarter US economic data showing unexpected resiliency, insurance companies’ investment officers are grappling with a new set of challenges as the year 2024 unravels.

The often-cited notion that interest rates will “stay higher for longer” during much of 2023 has prevailed, but the additional challenge for chief investment officers this year is that they must also keep track of interest rate expectations that are being constantly reset. The market is now pricing in one to two quarter-point cuts this year, down from an expectation of six to seven cuts in early 2024.

For Asia Pacific markets such as Hong Kong, new risk-based (RBC) capital regime, to be introduced in July, has put more urgency on insurers to match their long-term liability. Market risk capital charge for equity investments, for example, is higher compared to other instruments under the city’s RBC regime.

Adding to the complex macroeconomic and regulatory environment is the new IFRS 9 accounting standard , which has had a wide-ranging impact on how insurers account for and measure financial instruments.

Against such a backdrop, chief investment officers are taking positions on long-duration assets to better match their liabilities, as they seek to minimise the interest rate mismatch with the asset side of their balance sheets. Investing in longer-duration assets can help clients lock in the current level of long-term rates, said Thibaut Ferret, head of solutions Asia for HSBC Global Asset Management (Hong Kong).

“Some insurance companies are accelerating their allocation to longer duration assets, as they want to be able to lock in the current level of interest rate and mitigate the risk of rates falling. This makes investment grade fixed-rate infrastructure debt strategy a good fit, as their long duration helps match an insurer’s long-term liability while providing an illiquidity premium compared to listed bonds,” he said.

From a risk perspective, infrastructure debt has historically also delivered lower credit losses compared to similarly rated non-financial corporate bonds.

For chief investment officers requiring FVOCI (fair value through other comprehensive income) classification for their fixed income assets under IFRS9,  fixed-rate infrastructure debt strategies could prove relevant as they are likely to pass the SPPI (solely payments of principal and interest) test.

As the yield curve has inverted since July 2022, insurers that prefer to keep some exposure on the short-end of the curve to enhance portfolio yield could also benefit from shorter-tenor, floating-rate infrastructure debt, he said.

One option would be through transition infrastructure debt – its floating rate and illiquidity premium can provide compelling targeted returns while achieving net-zero, climate change mitigation outcomes.

Insurers have also shown a growing appetite for similar private credit strategies providing targeted equity-like returns and portfolio diversification, while benefiting from a fixed income capital charge.

Thibaut Ferret, HSBC Global Asset Management, InsuranceAsia News

“Insurance companies are accelerating their allocation to longer duration assets, as they want to be able to lock in the current level of interest rate and mitigate the risk of rates falling.”

Thibaut Ferret, HSBC Global Asset Management

Derivatives and securitisation

Insurers who have a view that interest rates could eventually go down this year are also taking tactical positions into long-term interest rates through derivatives, such as bond forwards.

They are also using bond forwards to pre-invest future insurance premiums at a pre-determined rate, and manage their overall asset duration more efficiently.

“We can help insurers assess, manage and execute these derivative strategies along with collateral management as these instruments are complementary to the core bond portfolio strategy matching liability that we traditionally manage for insurance companies,” he said.

Bond forwards are often a complementary tool to an insurer’s corporate bond investment, which helps manage their overall fixed-income portfolio efficiently.

“Having both forward and corporate bond could help insurers disconnect the credit spread duration and interest rate duration exposure, and therefore providing them with tools to manage more efficiently their overall portfolio,” he said.

For insurers that are comfortable with more complex securitisation strategies and are open to accessing different risk, return, and maturity tranches, HSBC Global Asset Management has also been offering securitised credits such as collateralised loan obligations, asset-backed securities, residential mortgage-backed securities.

Denominated in US dollar, securitised credits could yield an annual return of 6.5%.

Investment grade securitised credits also offer a complexity premium compared to corporate bonds that are attractive to insurers due to their efficient yield enhancement. These are often floating rate instruments with low spread duration and an external investment grade rating, thereby attracting a low capital charge under RBC.

“They help insurance companies achieve ambitious target yield for their overall portfolios, while at the same time, it is a liquid, investment grade-rated strategy with an acceptable level of capital charge similar to listed corporate bonds of similar rating and tenor,” he said.

Partner Content
Join the mailing list Designed to help you stay ahead, our daily newsletter provides a round-up of the latest news and insights, delivered straight to your inbox.
Print Edition
Subscribe to receive our quarterly print magazine.