Jeev Muthulingam, head of insurance investment solutions at NN Investment Partners, and Ulla Fetzer, client portfolio manager at the Dutch asset manager, discuss the multiple benefits private debt offers insurers as an asset class
What measurable benefits can private debt offer insurers as an asset class?
There are two reasons insurers access private debt: firstly, it provides diversification from pre-dominantly domestic government, government-related instruments and corporate bonds, which are relatively small in terms of exposure to names and sectors. Secondly, there is the significant risk-adjusted spreads or risk adjusted return on capital.
Private debt gives insurance investors the ability to tailor risk/return profiles and meet their investment objectives by lending at different leverage points and against different types of real assets.
The asset class provides strong investor and downside protection given its strong documentation and loan covenant features, as well as collateralisation, which is often through physical assets. The market turbulence of 2020 highlighted the need for an asset class, like private debt, that can offer resilience and stability.
Whilst spreads have been generally compressed across all sectors, these have been differentiated across domestic and cross currency markets. Considering capital and ESG adjusted metrics, there are still pockets of opportunities in "less travelled areas".
Insurers can therefore provide access to investment solutions that policyholders cannot directly access given the private nature, scale or complexity of private debt.
Is private debt becoming a popular alternative asset class for insurers?
What we are noticing across Europe is the general trend for insurers to broaden their asset allocations. This starts with a very narrow, often domestic, government and corporate bond allocation, and expanding this to alternatives and private debt.
Issuers are often unavailable in the public space to dilute domestic biases relative to existing fixed income allocations, and so the opportunity to diversify in-force allocations into sectors continues to be a strong driver in the rising popularity of private debt. Exposure to a broader set of de-correlated risk factors, creates the potential to outperform in adverse markets.
This can also be seen across European life insurers. Each insurer has a different allocation journey and a differentiated approach to achieve competitive pricing. The UK annuity insurance space is a prime example. They may write similar annuity books, yet there are material differences in the strategic asset allocation mix.
There is no uniformity across insurers, even within a single market, and there can be multiple reasons for this, such as internal models and types of liabilities.
In this context, illiquidity and complexity become additional risks, and can often be explained by the operational and structural complexity inherent to certain assets. Illiquidity premia offer a pick-up in spreads over traditional fixed income instruments.
Demand for illiquid private debt assets from insurers is currently supported by the current regulatory environment, such as Basel IV, which re-shapes banks' balance sheets, and has been incentivising the rotation of illiquidity towards other types of investors.
Tighter banking regulations are already leading to traditional lenders pulling back from some sectors, creating a financing gap that needs to be filled. More opportunities are consequently becoming available in alternative credit, spanning the spectrum of different credit risks and durations, such as infrastructure, project finance, commercial real estate or export and trade finance.
Why should insurers come to NNIP for expertise in private debt?
We are well placed to advise and develop attractive private debt solutions for insurers, and we have done so since 1992. We have built a well sourced and robust alternative credit platform. Within alternative credit, we had €57.2bn ($65bn) of assets under management (AUM) - as of 31 December 2021 - across a range of strategies to meet insurers' various allocation requirements.
In the coming years, the integration of environmental, social and governance (ESG) factors is high on insurers' agenda. NNIP is continuously exploring new ways of further integrating ESG considerations into its investment process and this underlines our ambition to deliver client-oriented investment solutions for insurers that deliver stable returns.
What is NNIP's outlook for the private debt sector in 2022, and how will this impact insurers?
Growth across alternative assets is expected to accelerate over the next five years with private debt likely to experience the fastest AUM growth.
Tighter banking regulations are already leading to traditional lenders pulling back from some sectors, creating a financing gap that needs to be filled. More opportunities are consequently becoming available in alternative credit, spanning the spectrum of different credit risks and durations, such as infrastructure, project finance and commercial real estate.
Sourcing and deployment capabilities will remain a crucial factor for successfully investing in alternative credit and should be thoroughly considered by investors.
Overall, insurance investors will not only find enhanced yield in private debt, but also benefit from stability in more volatile times.
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