united kingdomen
Enabling insurers to achieve capital-efficient returns

Enabling insurers to achieve capital-efficient returns

11-04-2019 | Insight

The majority of assets owned by insurers are invested in investment grade fixed income. In search of a way to achieve more capital-efficient returns, diversification and illiquidity premiums, insurers often turn to high yield markets and alternative asset classes. But we argue factor investing in corporate bonds is an attractive alternative approach to generating capital-efficient returns.

  • Patrick  Houweling
    Patrick
    Houweling
    Portfolio Manager
  • Frederik  Muskens
    Frederik
    Muskens
    Quantitative Researcher

Speed read

  • Factors enable long-term performance, cost efficiency and diversification
  • Factor strategies can easily integrate insurance capital requirements
  • Client case study highlights attractive return on capital of factor portfolios

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.

Stay informed on Credit investing with monthly mail updates
Stay informed on Credit investing with monthly mail updates
Subscribe

Source of diversification

Factor-based credit strategies provide an attractive alternative 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 neutralizing 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 therefore strongly improves diversification.

Attractive returns

Importantly, by systematically harvesting factor premiums, factor strategies can be expected to deliver both a higher risk-adjusted return and a higher return on capital than passive credit portfolios. Numerous academic studies on various asset classes, including stocks and bonds, have shown that factor portfolios deliver superior risk-adjusted returns over a full investment cycle, compared to a portfolio that passively tracks the market index.

Moreover, explicitly integrating insurance capital requirements into factor credit strategies can further enhance the return on capital. In our research, we found a strong positive correlation between the Solvency Capital Ratio and credit volatility.  Therefore, a factor portfolio not only generates a higher return to volatility ratio (i.e. Sharpe ratio) than the market, but also a higher return to capital ratio.

By tilting a portfolio towards bonds that score well with regard to factors, and avoiding bonds that have poor factor scores, investors can therefore construct a portfolio that generates a higher risk-adjusted return and a higher return on capital than a portfolio that passively tracks the market.

Cost-efficient building block

Robeco’s multi-factor credit strategies offer exposure to the low-risk, quality, value, momentum and size factors. We apply enhanced definitions for each factor. Compared to more generic factor definitions, such as those typically used in academic research, these enhanced definitions lead to higher risk-adjusted returns. Our strategies also explicitly take liquidity, transaction costs and turnover into account, and construct well-diversified portfolios with a better sustainability profile than the index. They therefore offer more realistic expectations for attainable improvements in the return-on-capital ratio.  

Ultimately, our factor credit strategies provide a cost-efficient building block for insurers. These strategies can also be tailored to address specific requirements, for example when insurers wish to match a liability cashflow stream or aim for a certain level of income from a low-turnover buy-and-maintain credit portfolio.

Enter your details and download the full pdf

Disclaimer:

This report is not available for users from countries where the offering of foreign financial services is not permitted, such as US Persons.

Your details are not shared with third parties. This information is exclusively intended for professional investors. All requests are checked.

Logo

Disclaimer

Please read this important information before proceeding further. It contains legal and regulatory notices relevant to the information contained on this website.

The information contained in the Website is NOT FOR RETAIL CLIENTS - The information contained in the Website is solely intended for professional investors, defined as investors which (1) qualify as professional clients within the meaning of the Markets in Financial Instruments Directive (MiFID), (2) have requested to be treated as professional clients within the meaning of the MiFID or (3) are authorized to receive such information under any other applicable laws. The value of the investments may fluctuate. Past performance is no guarantee of future results. Investors may not get back the amount originally invested. Neither Robeco Institutional Asset Management B.V. nor any of its affiliates guarantees the performance or the future returns of any investments. If the currency in which the past performance is displayed differs from the currency of the country in which you reside, then you should be aware that due to exchange rate fluctuations the performance shown may increase or decrease if converted into your local currency.

In the UK, Robeco Institutional Asset Management B.V. (“ROBECO”) only markets its funds to institutional clients and professional investors. Private investors seeking information about ROBECO should visit our corporate website www.robeco.com or contact their financial adviser. ROBECO will not be liable for any damages or losses suffered by private investors accessing these areas.

In the UK, ROBECO Funds has marketing approval for the funds listed on this website, all of which are UCITS funds. ROBECO is authorized by the AFM and subject to limited regulation by the Financial Conduct Authority. Details about the extent of our regulation by the Financial Conduct Authority are available from us on request.

Many of the protections provided by the United Kingdom regulatory framework may not apply to investments in ROBECO Funds, including access to the Financial Services Compensation Scheme and the Financial Ombudsman Service. No representation, warranty or undertaking is given as to the accuracy or completeness of the information on this website.

If you are not an institutional client or professional investor you should therefore not proceed. By proceeding please note that we will be treating you as a professional client for regulatory purposes and you agree to be bound by our terms and conditions.

If you do not accept these terms and conditions, as well as the terms of use of the website, please do not continue to use or access any pages on this website.

I Disagree