Insurers need to have higher capital buffers against risk if Solvency II comes into place, forcing many to rethink the investments they are in. A potential solution lies in credits with a lower risk profile – as the clock starts ticking for investors to act.
An EU decision scheduled for October is likely to set a firm timeframe for enforcing capital levels that insurers must hold. The long-awaited regulations put a much greater emphasis on reducing risk by forcing insurers to hold ‘ring-fenced’ capital buffers in case their investments suddenly fall in value.
As these institutions are simultaneously trying to find returns for policyholders it produces a Catch-22. It is easy enough to lower credit risk to close to zero: simply fill the portfolio with AAA-rated government bonds and very little capital will be required to offset it.
The problem here is that yields on sovereign bonds remain at historic lows, requiring investors to look at higher-yielding products such as corporate bonds – thereby raising risk and the capital needed to act as a buffer.
So what to do? Isn’t there a middle ground?
Robeco’s Euro Conservative Credits strategy offers a solution. It is ideal for investors who are not satisfied with the returns on super-safe sovereigns, but do not want to face the capital requirements that go hand in hand with owning riskier corporate bonds.
“Solvency II looks as if it could have been written for Conservative Credits as the strategy allows investors to adopt a low-risk, low-volatility strategy while also accruing returns for their own stakeholders,” says the strategy’s portfolio manager, Patrick Houweling, Ph.D.
‘The strategy sits in a sweet spot between AAA-rated government bonds and general credits’
A corporate bond’s risk depends on its duration and credit quality, which is reflected in its credit rating. The key to Conservative Credits’ risk reduction strategy is its lower duration and its higher credit quality than common benchmark indices.
The strategy invests in securities that have 2.4 years to run until maturity compared with 4.5 years for the Barclays Euro Corporate Bond Index. These shorter-duration securities have slightly higher average credit ratings and lower spreads against benchmark bonds.
Since longer-duration bonds have a higher sensitivity to rate movements and have wider spreads against benchmark sovereign bonds, shorter-duration securities are better suited to meet Solvency II requirements.
“The Conservative Credit strategy sits in a sweet spot between AAA-rated government bonds, which are ultra-safe but have low yields, and general credits, which may have better yields but are a lot riskier,” says Houweling.
And safer doesn’t necessarily mean less rewarding.
The strategy is able to generate superior risk-adjusted returns by exploiting the ‘low-risk anomaly’ in corporate bonds in the same way that the anomaly can be profitable in equity markets.
The anomaly exists because lower-risk securities have consistently outperformed higher-risk ones, contrary to the investment theory of the Capital Asset Pricing Model, which predicts that taking a lower risk should result in a lower return.
“Investors are realizing that the quantitative strategies used successfully for equities also apply to fixed income. The structure of the quantitative model for credits is very similar to the one we use for equity,” says Houweling.
“There is a great deal of cross-over between how a company’s equity and debt is viewed quantitatively. The risk indicators that we use are identical, such as targeting companies with low leverage, a large equity cushion and low equity volatility.”
|A Sharpe-r performance||Timeline|
|The Conservative Credits portfolio has a consistently higher Sharpe ratio, which measures the risk-adjusted rates of returns on an asset. At the end of the strategy’s first full year of operation in May 2013, it had a Sharpe ratio of 1.96, well above the market’s Sharpe ratio of 1.57. In general, bonds with shorter maturities and higher ratings have been shown to have higher Sharpe ratios than those with longer maturities and lower ratings.||The issue will be next be discussed by the EU Parliament on 22 October. MEPs first need to agree the wording of the Omnibus II Directive, which will amend certain provisions of the Solvency II Directive, including its timeframe and implementation date. Originally set for 1 January 2014, most EU governments and their financial institutions are not yet ready to implement it, and most industry participants expect the deadline to be put back until 2014.|
The strategy focuses on euro-denominated corporate bonds, though the issuers may be domiciled outside the EMU, such as McDonalds (US), Vodafone (UK), Nestle (Switzerland) and Carlsberg (Denmark). Risk is spread across regions and sectors. A second strategy investing in global bonds denominated in all currencies is also available.
Aside from the lower duration characteristic, risk is spread by investing in more companies than regular corporate bond funds, with about 100 in the Conservative Credits portfolio compared to 60-80 for a typical credit fund, and with lower concentrations in one region, sector or company.
The table below shows how the low-risk nature of the portfolio can be seen in its lower volatility relative to the benchmark (beta), shorter duration, higher credit ratings and less concentrated positions.
|Robeco Euro Conservative Credits||Barclays Euro Corporate Bond Index|
|Duration||2.4 years||4.3 years|
|Spreads vs German govies||1.1%||1.3%|
|Largest sector weight||23%||48%|
|Largest company weight||1.5%||3.4%|
|Largest region weight||39%||62%|
Source: Robeco, Barclays, September 2013
The content displayed on this website is exclusively directed at qualified investors, as defined in the swiss collective investment schemes act of 23 june 2006 ("cisa") and its implementing ordinance, or at “independent asset managers” which meet additional requirements as set out below. Qualified investors are in particular regulated financial intermediaries such as banks, securities dealers, fund management companies and asset managers of collective investment schemes and central banks, regulated insurance companies, public entities and retirement benefits institutions with professional treasury or companies with professional treasury.
The contents, however, are not intended for non-qualified investors. By clicking "I agree" below, you confirm and acknowledge that you act in your capacity as qualified investor pursuant to CISA or as an “independent asset manager” who meets the additional requirements set out hereafter. In the event that you are an "independent asset manager" who meets all the requirements set out in Art. 3 para. 2 let. c) CISA in conjunction with Art. 3 CISO, by clicking "I Agree" below you confirm that you will use the content of this website only for those of your clients which are qualified investors pursuant to CISA.
Representative in Switzerland of the foreign funds registered with the Swiss Financial Market Supervisory Authority ("FINMA") for distribution in or from Switzerland to non-qualified investors is ACOLIN Fund Services AG, Affolternstrasse 56, 8050 Zürich, and the paying agent is UBS Switzerland AG, Bahnhofstrasse 45, 8001 Zürich. Please consult www.finma.ch for a list of FINMA registered funds.
Neither information nor any opinion expressed on the website constitutes a solicitation, an offer or a recommendation to buy, sell or dispose of any investment, to engage in any other transaction or to provide any investment advice or service. An investment in a Robeco/RobecoSAM AG product should only be made after reading the related legal documents such as management regulations, articles of association, prospectuses, key investor information documents and annual and semi-annual reports, which can be all be obtained free of charge at this website, at the registered seat of the representative in Switzerland, as well as at the Robeco/RobecoSAM AG offices in each country where Robeco has a presence. In respect of the funds distributed in Switzerland, the place of performance and jurisdiction is the registered office of the representative in Switzerland.
This website is not directed to any person in any jurisdiction where, by reason of that person's nationality, residence or otherwise, the publication or availability of this website is prohibited. Persons in respect of whom such prohibitions apply must not access this website.