In the second part of this interview, Generali group CIO Francesco Martorana discusses on the merry-go-round of asset classes the Italian giant invests in, and provides an outlook for the next 12 to 18 months
The last two years – 2022, 2023 – have been characterised by a rapid increase in interest rates, the speed of which can have been a headache for bond investors. How have you managed it at Generali?
Until 18 months ago, typically the discussion was 'are we in a Japanese scenario?'. And strategically we took a lot of actions, both in terms of new business mix, but also the disposal of certain portfolios, to reduce our exposures and prepare ourselves for lower interest rates and to have a 'balance sheet-light' approach.
Then, interest rates moved very quickly, nobody expected this. Higher interest rates are good for our industry, both in life and P&C because we have a spread business, so we should be happy to have higher interest rates. The issue was the speed of adjustment.
It was a difficult year because, clearly, when interest rates increase so quickly, there is a lag effect, which happened in 2022, but it was felt even more so in 2023, in terms of inflows. You need to have robust ALM, and we managed 2023 pretty well.
We had outflows in traditional life mainly in the bancassurance channel in France, but in Italy and all the other countries we have a really strong distribution through tied-agents or exclusive agreements. So, contrary to other players, we controlled the dynamics in terms of outflows and were able to reinvest in higher interest rates.
My expectation is that the situation has now stabilized because interest rates have stabilized. Last year, we saw the more dynamic part of our portfolio in terms of liabilities in distribution moving, especially high net worth clients who are more return-sensitive, more dynamic and sophisticated. Now interest rates probably have stabilized, so we are going to have a more controlled dynamic on the outflows.
We also took actions on the product side: we launched new products, we tried to be competitive in terms of increasing the return of our funds. This has to be managed on both the asset and the liability sides, but I think we manage it well and we didn't have a stressful situation. Of course, we had some unrealized losses on bonds, like anybody, due to our duration, but the important thing is the liability part.
You mentioned an appetite to increase allocation to private debt, can you tell us a bit more?
Most of our portfolio is in investment-grade corporate bonds, and given our liability needs, mainly in Europe. Direct lending gives us, first, some illiquidity premium. Second, it gives us access to borrowers which are typically mid-market companies or even smaller SMEs, which is a set of borrowers that typically does not have access to capital markets, whether it's high yield bonds, or syndicated loans. So, it gives us access to this segment of the market.
We typically play in the senior part of the capital structure, where you have a lot of covenants, and when you work with large asset managers, you have a significant stake in the deal. In case something goes wrong, you can take control of the situation, whether it is a restructuring or other [situation].
The bottom line is, there is an illiquidity component, there is clearly a credit spread component, shorter in duration as it is a floating asset class. It gives us access to borrowers which otherwise are not available in the public credit markets.
You also mention an appetite for real estate, it is an interesting asset class at the moment, there are some concerns, both in terms of some segments of real estate, but also some geographies -what are your views?
Our portfolio is almost entirely in continental Europe core offices, and to some extent in the Nordics and the UK. It is a high-quality portfolio in terms of location, we're talking about prime assets, usually, and increasingly, with high ESG characteristics.
We observe that the vacancy rate in our portfolio remains very low, the rents for this type of buildings keep increasing, and during 2022 and 2023 we also benefited from inflation indexation.
In terms of appraisal value, the appraisers are conservative, and due to the increase in the cap rates, there is a deflection in the valuation. But this is mark to market. In reality the market is quite illiquid, so we don't see many transaction going on.
We are very confident in the quality of our portfolio. It produces an attractive and growing income. We see in the market assets which are suffering - clearly peripheral offices or buildings with low ESG characteristics are suffering. But they represent a very minor portion of our portfolio.
Another element which is important is the leverage. Usually real estate is a levered asset classes, so cyclical, and in this situation it's suffering. We use a very low amount of leverage, usually below 15%. The absence of leverage is a plus in this situation.
More broadly, my view on real estate, is that it could be that we are see in the US, and probably also in Europe and Asia, another six to 12 months of pressure, so valuations might decrease again, and there could be forced sellers.
But I start to see the light at the end of the tunnel, hoping that it is the true daylight and not the train coming towards us.
In the US, both on the debt and equity side, prices are dislocated because you have only sellers and no buyers. This typically also makes opportunities for players like us with strong balance sheets and cash exposures, to step in and take some bargains, even if clearly we are not typically an aggressive player, and we want to play cautiously.
There is another element – linked to private debt - which is structural. It is the fact that banks, due to regulation, are retreating massively from mid-market lending to SMEs and mid-market companies. So, structurally, we see that the role private assets will play in the balance sheet of large asset owners, like insurance companies and pensions, will grow.
And equities - what is the story there?
We have been growing our private equity exposure in the last five to seven years. It has produced, so far, not only attractive absolute returns, but an attractive multiple versus the listed equity market.
Our approach has always been to focus on mid-market, general partners. So not the large buyouts, but typically those GPs that really can work on the portfolio companies to generate operational improvements and organic or inorganic growth, rather than those using too much financial leverage.
So far, even last year it was a tough market, this strategy has paid off, because those that were very focused on the venture sector, or on highly-leveraged strategies, suffered. Our focus is really mid- market buyout, or secondaries. Secondaries gave us attractive returns in these vintages. They are even more attractive because there are a lot of forced sellers and people over-allocated to private equity.
Private equity is an important asset class in our strategic asset allocation. Of course, it's equities, so we cannot expect private equity to be 'all-weather', to perform in any possible scenario. But it is an important return engine.
You mentioned that the unit-linked business is growing... that was driven by low interest rates... what are the dynamics now that the interest rates are high?
We see from clients an appetite for hybrid products. What we sell is not pure unit-linked, but typically it is a bundled contract where you have a component of it going into the general account, providing a sort of capital guarantee or premium refund, and the remaining part going into unit-linked funds.
From an overall risk/return profile, you still have a conservative type of product, but you have some more interesting upside to equity and to other risk factors.
Our approach has been not to focus only on the financial component and on the returns, but to also give an insurance component. We want the product to serve a certain need, not just to provide the financial return, so we've been successful in adding, for instance, protection layers to our products. Like, term life or invalidity or long-term care, which is something our clients appreciate.
Lastly, in some jurisdictions - not in all - but if you look in France and in Germany, actually the unit-linked wrapper allows also the provision of exposure for clients to private assets, whether it's real estate, private equity, private debt - so it's also a way to democratize these assets, which are difficult to access. Considering they are illiquid products, we always provide exposure which is diversified and does not exceed a certain percentage of the premium, or the wealth of the client.
Looking at 2024 and 2025 are you optimistic, cautious, pessimistic?
If we look back at 2023, most of the players in the market, including us, were expecting a hard landing or recession, which didn't occur. So the economy and financial markets were much stronger than we expected.
Now, we are in a situation where the markets are priced almost for perfection. So there is a bit of exuberance in both equity and credit, we see some valuations being a bit excessive for where we are in the cycle. So, we are rather prudent on the outlook. But we don't expect hard landing or harsh recession, we expect more of a soft landing.
The markets are probably not fully pricing in the geopolitical risks because this year, we have more than 50% of the world population voting. We have important elections first and foremost in the US. We have two wars ongoing. The market so far seems to neglect all these elements. But my experience tells me that, at some point, this can give us some volatility, and markets can wake up and focus on those risks. So we prefer to be prudent, and we see value more in the credit space in this phase – investment-grade corporate bonds and private debt.
For listed equity – honestly, it is a tough call, because the reality is that more and more you cannot make a call at the index level, because in reality you have specific sectors or stocks – 'The Magnificent Seven' [of Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia, and Tesla] - and a lot of dispersion across sectors and geographies. If you look also within emerging markets, there is a very strong dispersion. I would refrain from saying we are bullish or bearish on equities as a whole, because we have to go one or two levels deeper, and take a view on the sector and the geographical areas.
Part one of this interview is available here.