The threat of recession has cast a shadow over triple-B rated US corporate bonds - and even triple-A rated bonds could soon look like tainted assets, according to speakers at the AsianInvestor Insurance Investment Briefing in Hong Kong on September 30.
With the US Federal Reserve battling inflation through a series of interest rate hikes, the concern now is not if, but when, a recession will hit and how long and severe it might be.
For Hong Kong-based insurers grappling with a limited government bond market - and with a preference for US corporate bonds - recession is set to be one of the major challenges to the sector going forward.
“During recent years, we and other Hong Kong insurers have been piling up triple-B or triple-B minus US corporate bonds with yields that have been pushed by choices more than anything else, in the sense that you don’t have that many choices in the market," Gregoire Picquot, chief financial officer at BNP Paribas Cardif, said from the stage.
"In a low-rate environment you still need to meet your yield targets, but the risk is still present,” he said. “So, if we have a downturn and recession – and that could be announced very soon in the US – and if we see the default rates rising in triple-B bonds it will be a double pain.
"It will be a pain from a P&L (profit and loss) and mark-to-market view, and it will be a pain in terms of capital. That is something that we are very aware of and therefore very careful of in our concentration of triple-B corporate bonds,” Picquot added.
GO FOR HIGHER RATING
Courtney Wei, deputy general manager at the investment management department at China Life Insurance (Overseas) shared the view that if insurers are making new investments in US corporate bonds, they should definitely aim for a higher rating than before but at the same time still stick to their existing allocation of triple-B bonds.
With the increasing likelihood that the US will see a prolonged environment with higher interest rates, it may bring both a deeper and longer recession that will hit insurers in terms of various kinds of default or downgrade risks, according to Wei.
“We should probably look at other risky parts of our bond investments," she said.
"We have other structured products where their ratings are now triple-A, but sometimes even triple-A is not even safe enough. So we should review all those exposures at this moment, and having that in the back of our minds,” she said.
Max Davies, insurance strategist at Wellington Management, pointed out that the exposure to triple-B corporate bonds has ballooned massively in the past few years - a trend that includes insurers not only given their sensitivities to high yields from a capital charge perspective but also their desire for greater yields.
“If we do have a prolonged downturn, there could be some downgrade risk from triple-B bonds to high yield which would cause a lot of insurers to be (forced) sellers due to capital charges.
"Also, with the use of matching adjustment downgrades there is a lot of sensitivity to downgrades within that framework. It is an area that will really expose the importance, once again, of active management and fundamental research so that you can avoid some of those pitfalls,” Davies said.