Insurers of all categories have demonstrated an increasing level of interest in Emerging Market Debt in recent years and there are signs that the category could become a mainstay in insurance general accounts. Although there appears to be a healthy appetite for both corporate and sovereign EMD issuance from the insurance industry, on the sovereign side recent auctions by the governments of Ukraine, Indonesia, Saudi Arabia and Romania (among others) have been heavily subscribed by insurance investors. This has been taken as a sign by some that the industry is now embracing Emerging Market Debt.
For annuity investors in the UK, a category of insurer which has arguably invested the most time, effort and capital in sourcing direct illiquid credit investments over the past 5-10 years, there is unrelenting pressure to capture higher yielding investments - but ever fewer assets available at investment grade which can reasonably be expected to do so. Since pricing in the bulk annuities space in particular can be highly competitive, emerging market debt represents an attractive, higher yielding asset which (provided the security is issued in hard currency) receives broadly comparable treatment under the Solvency 2 prudential rules to that of other bonds. EMD also offers a relative degree of liquidity to insurers looking to book shorter duration liability streams in the with-profits or property & casualty sectors.
Clearly, in the prevailing low rates environment there is plenty of incentive to acquire enhanced credit in all of its various categories, with short duration high yield strategies also featuring prominently. For some time EMD hard currency debt has yielded roughly twice the annual return of developed market investment grade bonds. Moreover, the technology acquired by insurers in recent years, as they have built up their own Ratings capabilities, in order to securitise direct investments themselves has added a degree of confidence in their ability to analyse and rate complex or esoteric categories of credit.
Meanwhile, in relative terms, the gap between default rates for EMD and developed market bonds has been narrowing, whilst overall issuer debt levels (in the sovereign side of the market at least) have fallen. The underlying risks held in Emerging Market Debt have also become increasingly diversified.
As a result, a number of global asset managers, such as BlueBay or BlackRock have been working hard in recent years to develop EMD-based products for long-only insurance investors.
...So there are plenty of reasons for insurers and pension funds to maintain their heightened levels of interest in the asset class, however insurance companies would do well to maintain a degree of caution because, as the IMF pointed out in its October Financial Stability Report, there are systemic risks. The IPE's Daniel Ben-Ami takes up the story...
What starts off as a positive move by some individuals can over time morph into a serious problem for the world more generally. Good intentions can in some cases end up unwittingly producing damaging results. Such a quandary arguably exists in relation to emerging market debt. At present, it makes sense for advanced economy investors seeking a higher yield on their investments to at least dip their toe into the asset class. After over a decade of ultra-loose monetary policy in the developed markets (two decades in Japan), the potential returns available at home in look meagre. With an estimated $15trn (€14trn) of yielding negative returns it makes sense for many investors to shift some of their allocation to emerging markets. But beyond a certain point, the flow of capital to the developing world could create difficulties...