Real estate, infrastructure and private debt used to add purpose to its investment strategy
Private market investments can play an important role in enabling insurance companies to drive UK growth, according to the head of strategy at a major UK insurer.
L&G is already the UK’s largest LDI manager and is targeting £50-65 billion of pension risk transfer (PRT) business over the next five years. “That’s a massive amount of assets to back liabilities,” said Sumit Mehta.
It faces a commercial outlook with “very competitive pricing”, according to Mehta. “It means there is always commercial pressure to take risk, especially in this macro environment. We need to manage the liquidity of the book appropriately while paying dividends to shareholders.”
L&G’s strategy is not purely based on financial objectives. “Purpose is a key tenet for us,” says Mehta. “We want to invest in the real economy. I feel very strongly that the insurance industry has a big role to play – and the ‘how’ part is important.”
“Manufacturing [rather than originating] assets either lowers the cost of capital or creates financing for a new activity where it doesn’t currently exist.”
Mehta conceptually separates the portfolio into liability-backing assets, mostly in fixed income, where it earns “the net lifetime spread…. from the assets over liabilities over their life”, from the assets backing its capital, which it thinks about strategically to support the wider portfolio and business.
The liability-backing portfolio is necessarily constrained by liability matching and the associated duration consideration. “At the book level, we need to generate assets of the right duration to match liabilities… When doing that, we’ve got a duty to our shareholders to look at the economics. A key tenet of our strategy is doing that while retaining that element of purpose: investing in the economy.
“More interesting is the shareholder funds component where we have some limited capacity to contribute equity-style financing that can help manufacture assets, both for the MA [matching adjustment] portfolio objective and to help drive our purpose objectives.”
Mehta says L&G is comfortable with manging credit risk in private markets. “A big part of our [allocation] has been across real estate, but also in various types of infrastructure, including clean energy, and different areas of private lending,” he says, noting that the latter is akin to public corporate debt but with an illiquidity premium.
Looking ahead
Insurers’ strategies need to constantly adapt to economic circumstances for their portfolios to remain optimised.
“We are focused on secular trends,” he said. “However, capturing opportunities arising from them requires us to cautiously enhance our risk appetite, which we are thinking carefully about”.
“Banks are retrenching from areas where they have traditionally been strong, such as private credit and asset-backed finance. European insurers have long been underweight in some of those asset classes compared to US insurers – so there are opportunities.”
However, he noted that insurers around the world are increasingly allocating to private assets. “The downside is we see crowding, especially in the long duration space. The limited supply of assets means we are seeing an erosion of liquidity premium.”
Mehta noted that the removal of the sub-IG cliff in Solvency UK presents opportunities.
He added: “While the risk capital element limits that to an extent, there are some interesting areas. How do we finance the sub-IG asset class of transition infrastructure debt? Given the risk constraints when allocating to such asset classes, we’ve got to think about where we get the biggest bang for our buck.”