Insurance companies are significant investors in credits and hold capital buffers to protect their portfolios against negative events. Insurers are also always looking for the best way to diversify their investments and to enhance their return on insurance capital.
Source of diversification
Factor-based credit strategies provide diversification benefits to traditional, fundamental, research-based credit strategies for insurers. Their differentiated investment style and their ability to utilize a broader investment universe explain why factor strategies provide an important source of diversification relative to the fundamentally managed portfolios of insurers.
A multi-factor credit strategy uses a highly systematic method to construct the portfolio, taking into account multiple quantitative factors and is designed to neutralize the portfolio’s exposures in terms of interest rate duration and credit beta. Meanwhile, fundamental strategies typically follow only one style, often carry or value, and regularly take duration and/or beta bets.
In terms of the investment universe, a factor-based strategy can efficiently invest in all companies and bonds, irrespective of their size. Fundamental managers inevitably have to focus on a smaller subset, given their limited resources for analyzing issuers. Generally, this subset consists of the larger, more liquid names and their more recently issued bonds.
Because of these differences, while the realized returns of most fundamental strategies tend to be positively correlated, the realized returns of our factor strategies are negatively correlated with those of their fundamental peers. Adding a factor strategy to a portfolio of fundamentally managed credit strategies can be a strong diversifier.