Michele Gaffo, Global Head of Insurance Coverage at DWS and Head of EMEA for DWS's Alternative Investment Specialists, explains the appeal of real assets for insurers and shares his outlook on the market.
What are the main trends in infrastructure and real assets investments?
Real assets include real estate, infrastructure and other tangible assets. You can have access to these assets via private deals or listed deals. In both ways, we are well equipped. We are particularly strong in infrastructure and real estate. Our real assets brand, RREEF, is extremely well known and highly respected in the US, and we have also exported the same approach to Europe and Asia. The reason why a real assets platform like ours is very compelling for insurance companies is due to the persistent low interest rates environment. Also, since Solvency II was implemented in 2016, insurers have had to become much more creative in how to sustain portfolio returns. The result has been a prominent shift from traditional fixed income into more illiquid assets and private debt. In addition, infrastructure equity transactions can be appealing to insurance companies because Eiopa allows insurers to have fairly benign risk capital treatment on qualifying infrastructure investments. For insurers, investing in infrastructure offers the opportunity to achieve stable recurring yield to meet any potential future liabilities. The yield offered by infrastructure is enhanced, compared to traditional equities or bonds, and is ordinarily resilient through the cycle. Since insurers are focused on cash yield having stability, they may be tempted to invest purely in core infrastructure as a 'safe bet'. Returns in the segment are compressing, however, so moving up the risk/return spectrum into Core Plus offers insurers access to higher returns, and higher as well as stable cash yield.
What's your outlook for infrastructure and real assets over the next year?
There will be several competing trends, dependent on how severe the coronavirus situation will prevail. On one side, I think the appetite for private assets will continue while interest rates will continue to stay low. The second is that private markets will turn out to be much less volatile than listed markets, especially with the current stress in the financial services sector, we can see how volatile equity markets are. However, we also need to acknowledge, and this is on the debt side, if we enter into a recession, I do expect the entire spread environment will widen. More traditional investors might come to the conclusion that via more standard liquid fixed income strategies, they can achieve a return that is good enough, and perhaps there may be less need for illiquid debt transactions. For sure, several strategies will soon be tested if we start witnessing defaults in the market.
In terms of passive investment, what benefits does it offer insurers?
If you look at the industry in its entirety, delivering stable alpha is a challenge. In highly liquid and large stocks, we have been witnessing a strong appetite from large institutional investors to move in the passive investment direction because they came to the conclusion, they would rather create value via strategic asset allocation, than bottom-up alpha creation. Another trend we notice in the passive space is the proliferation of environmental, social and governance ETFs. We became very strong in doing index customisation. This means embracing ways to change the benchmark that is still in a passive framework, but in a way that is more tailor-made. It is also worth mentioning you need a certain size to provide passive investments and stay profitable. We are in that league and are the second largest ETF provider in Europe.
How do you expect the passive asset management sector to develop?
The next few months will be complicated. The coronavirus represents a challenge for the entire economic environment. It will be a topic for global markets in its entirety and emphasises the importance of a strong risk management culture. With the trend towards independence and Brexit for example, the coronavirus outbreak might help foster more tolerance as countries will realise they need each other's support.