The constraints of ALM

Jeon Young-muk heads asset portfolio management for the general account of Samsung Life Insurance, which, with $150 billion of assets under management, is the fourth largest in Asia ex-Japan. Jeon has been with Samsung Life for 27 years, the past 15 of them with its portfolio management team.

Q What defines your asset allocation?

A Our liability structure. We are still dealing with policies sold 20 years ago when Korean interest rates were in double digits. Rates today may be higher than they were a year ago, but they are still low by historical standards. But for the majority of our outstanding policies, the average liability rate of interest is 7%, or higher.

Even though we continue to collect new premiums based on these long-existing contracts, we have to continue to guarantee payouts based on interest rates from long ago.

Q What does that imply for how you invest for the general account?

A We cannot decrease our allocation to fixed income until 2016 at least.

Q How do you match the assets in your portfolio to those liabilities?

A Like most insurance companies, we are guided by the principle of asset-liability matching (ALM). That means most of our portfolio is allocated to fixed income, particularly assets at the safer end of the risk spectrum. Most of our portfolio is domestic government bonds.

The asset allocation is different for our separate account assets, which are sold on the back of variable annuity products.

Q How else do you match assets to liabilities?

A In addition to fixed income, we invest in loans. We buy floating-rate notes. Together with fixed income, that makes up over 80% of the total portfolio. Of the rest, about 15% is in equities – including allocation to stocks in other affiliates of the Samsung Group – and 5% is in real estate.

Q How much of that total is invested overseas?

A About 8%. Of that, half is to foreign-currency bonds issued by Korean companies and government agencies.

Q What has been the biggest change to your portfolio since 2008?

A Our overseas exposure. Before 2008, we had 13% of our assets in foreign markets, particularly to bonds from US and European issuers. We hedged the cash flow with currency swaps, so we’d get paid in won. During the global financial crisis (GFC), we had to sell the riskiest assets. We were required to sell bonds before maturity and lost on that.

We also had to unwind foreign exchange swaps, which came with a cost. And the won was appreciating against the dollar, so we got hurt a third way. Since that time we have been careful about investing overseas. It brings us credit risk, market risk and hedging risk. And even though we had hedged currency risk, those contracts only applied to holding bonds to maturity, and we found we had no protection when we sold them early.

Q Do you see your foreign exposure increasing again?

A Yes. We have investment branches in New York and London. They are looking at adding both more securities as well as third-party managers.

Q To what extent do you work with external managers?

A We cut back the number during the GFC. But we kept relations with other insurance groups, such as New York Life, Prudential and Allianz. We continue to learn from them about managing global portfolios, and share information on insurance products.

Q What about for alternative investments?

A We do invest in private equity such as buyout funds. For these things we always use external managers. But it is a small part of our portfolio.

Q You mentioned you have a dedicated allocation to real estate?

A Yes. Two years ago we set up a company called Samsung Real Estate Asset Management, and last year we invested with Samsung Electronics in a building in London – our first overseas real estate deal in 15 years. We own 90% of the building, and Samsung Electronics, which is using the building, owns 10%.

Q London seems to be hot right now?

A Last year saw many Korean financial groups invest in London property. We like it because you can get rental contracts as far out as 20 or 30 years. In Korea, rental contracts are usually just two or three years.

We’d like to find more opportunities in this area, not just in the UK but also in the US and other parts of Europe, but it’s harder now because there’s a lot of competition.

Q How have your private-equity managers performed?

A We have been satisfied with them. We expect a higher return from private equity and although the allocation is small, we have a long history of investing in this asset class.

In the early years we experienced some losses, but our average return has been very good. PE requires selecting good managers, by understanding their due diligence and risk management processes. There is someone in our investment team whose job it is to look at this.

Q What’s your world outlook, what do you pay attention to the most?

A Will interest rates go up? Korea is heavily dependent on exports and we expect this economy to grow. But we’re concerned about China, and the prospect of interest-rate rises in the US. So, too, rates in Korea: our [consumer-price index] inflation probably saw the bottom last year and is now around 1.5-1.8%.

Q How do you respond when you have such a massive exposure to fixed income?

A It’s a concern. We hear advice that tells us to reduce our duration or simply get out of fixed income. But who will guarantee that interest rates will go up – by how much, how fast?

Maybe we can hedge that risk, but we need to be mindful that our liability’s duration is much longer than our asset duration. So if rates go up, yes we may lose on the asset side, but we can’t undermine our ALM: that would be more dangerous than accepted losses in the portfolio. And if rate hikes are modest and gradual, the pain won’t be so great.

Q Why not just go to cash?

A We sometimes hear we should put more of our new revenues into cash instead of bonds – but then we risk being shut out of the market when interest rates go up. There may then be fewer issuers of long-term bonds. It’s prudent to get hold of long-term assets now while there’s plenty of supply.

Q Is the supply situation adequate now?

A There’s plenty in the domestic bond market. The government has been issuing 20-year bonds since 2006, and 30-year bonds since 2011. Other institutions have since followed.

The domestic market is small relative to our needs, but we have to hedge our cash flow to won when we go to the US, and as I explained a little earlier, that was a bad experience. We can’t completely hedge our position without giving up the benefits of long-duration assets.

Q Are you moving into other Asian bond markets?

A We do hold some government and agency bonds from other countries in the region, but the challenges are the same. Also, regulations require insurance companies in Korea to buy securities with a minimum credit rating of BBB+, so that puts many Asian names out of reach.

Q How do you approach stocks?

A Our exposure is small compared with fixed income, but changes in the market can be volatile, and that’s a problem for us. Accounting rules force us to realise a loss when we mark securities to market. In the case of bonds, those losses would go to the balance sheet, but losses in equities go on our P&L.

Q What is the first thing you look for when considering third-party managers?

A The first thing we check is track record. Secondly, we want to learn from our managers, so we ask about how they can transfer knowledge to us. Sometimes they might take on our employees, which is very helpful. We have a close relationship with New York Life Investments. Last year we launched the Samsung-US Dynamic Asset Allocation Fund with them.

Our office in New York invests in US equities and New York Life invests in fixed income, and we sell it in Korea via Samsung Asset Management. We hope to invest in US real estate next. We want to develop this [relationship] more.