Three strategies for optimising liability-matching fixed income portfolios in Asia

To address issues arising from new regulations and accounting standards, many insurers in Asia are turning to liability driven fixed-income investment. They consider liability characteristics like exposure to interest rate and currency risk when constructing fixed income portfolios.

Some insurers are going further to build matching adjustment (MA) portfolios. This helps them realise potential benefits under Hong Kong’s risk-based capital (RBC) and Singapore’s RBC2 regulatory regimes. The benefits include lower RBC requirements and lower values for eligible liabilities (including some participating and non-participating liabilities), as they are discounted using the spread of assets in the MA portfolio, after it is adjusted for expected defaults.

However, these benefits are only available if MA rules are followed, which include retaining a separate MA portfolio of high-quality fixed income assets that closely matches the cash flow profile of the MA liabilities. There is nuance and complexity to the MA rules. Even as they differ by country –– Singapore, for example limits portfolios to investment grade fixed income, while Hong Kong permits some equities and property assets — the principles are the same.

Learnings from the rest of the world

Legal & General, the parent company of Legal & General investment Management (LGIM), is a global life insurance provider and one of the biggest players in the highly competitive UK annuity market. Liability-driven fixed income investment has been a fixture in the UK for over 20 years. MA portfolios have been available since 2016 when Solvency II was introduced. We believe that some of the lessons we have learned apply in an Asian insurer context.

Go global: We now have fixed income investors and credit researchers in both London and Chicago, as well as Hong Kong and Singapore. This has allowed us to diversify our credit exposures and access longer-duration assets with greater liquidity than is available in our domestic market, as well as pursuing attractive entry points where overseas markets have offered more attractive returns. Insurance regulations require robust ALM, including the managing of interest rate and currency risk. As a leading derivative asset manager in the UK and the US, our specialists deploy hedging strategies, including cross-currency and interest rate swaps, to minimise risk while optimising derivative collateral to maximise return.

Go private: This has allowed us to improve risk/capital-adjusted returns and increase diversification. Across the UK and the US, we have 50 investment professionals originating private debt assets. Their focus is on high quality, typically investment grade, MA-eligible assets with long durations to match our long-duration liabilities. In many cases, external ratings are not available. Our 20-person strong team, with reporting lines to our group CRO, provide internal ratings using methodologies mirroring those of the key rating agencies. This robust approach to risk management is rooted in our heritage as an insurance company founded 188 years ago.

Pursue net zero: We do not see it as a choice between financial returns and seeking to manage emissions connected to our investments — they can complement one another. So far, we have been able to meet our goals around both financial performance and carbon ahead of target. By the end of 2023, the greenhouse gas emission intensity of Legal & General’s investment portfolio had fallen by 30% from our 2019 baseline — well ahead of our target decarbonisation pathway^[1].

Investing through an Asian insurance lens

As insurers, we do not only make our investment decisions based on economic criteria. We have to consider insurance regulations, including regulatory capital and its accounting impact.

The economic case (return, diversification, liquidity) needs to be weighed against regulatory capital implications, as we can see in the chart below:

For Asian life insurers, the regulatory capital impact can be reduced if the assets are in an MA portfolio. In Singapore, MA portfolios effectively require cash flow matching and are limited to SGD and USD-denominated assets. The benefit is that the required credit spread risk requirement is 50%-80% lower than shown above.

Meanwhile, if we include high-quality private credit, we must remember these assets are mostly unrated by eligible agencies. Having internal ratings approved by the relevant insurance regulatory authority is critical to unlocking the capital benefits, that otherwise gets assigned a capital charge based on a rating between BBB and BB.

Meanwhile, Asian insurers also need to pay attention to the impact of their investment strategies on accounting profit and loss. For many insurers in the region, the IFRS accounting standards now apply (including market-consistent valuation of life insurance liabilities under the IFRS17 and the IFRS9 standards for valuing assets). We find that using the fair value through other comprehensive income (FVOCI) or amortised cost (AC) classifications for valuing eligible fixed income assets under IFRS9 can help manage accounting volatility.

At the same time, for those on a carbon reduction pathway, choosing the right ESG metrics is key. For example, we find that forward-looking measures like implied temperature alignment can be more appropriate as a metric to embed into investment mandates.

There are multiple considerations Asian insurers need to take into account as the market matures. Liability-driven fixed income investment is clearly here to stay in Asia — which makes accessing the right expertise, including the right asset management partner, even more important.

James Hayes is head of insurance client team, LGIM.

Disclaimer:

About LGIM Legal & General’s Asset Management Division

For professional investors only. Capital at risk.

L&G’s Asset Management division is one of Europe’s largest and a major global investor across public and private markets, with $1.420 trillion USD* in assets under management. The division combines deep expertise in asset management and origination with global distribution capabilities to deliver positive outcomes for our clients, which include individual savers, pension scheme members and global institutions and insurance companies, investing alongside L&G’s own insurance balance sheet. As a global investor, we are present where our clients need us – from Hong Kong and Singapore, to major European financial hubs, to Chicago – operating under the Legal & General and LGIM brands. We provide investment solutions across the full spectrum of asset classes, ranging from index-tracking and active funds to liquidity and liability-based risk management strategies. Through our private markets platform, we utilise our rich heritage and extensive network of partners to offer access to a wide range of purposeful alternative investment opportunities, including specialist real estate, clean energy, infrastructure, venture capital, unlisted equities and private credit. Our division is underpinned by our enduring commitment to responsible investment, dedicated to creating long-term, sustainable value for our clients and partners.

*Source: Legal & General internal data as of 30 June 2024. The AUM disclosed aggregates the assets managed by LGIM in the UK, LGIMA in the US and LGIM Asia in Hong Kong (2018-2019 only) and LGIM Singapore from July 2023. Excludes assets managed by associates (Pemberton, NTR, BTR)

It should be noted that diversification is no guarantee against a loss in a declining market.

Key risk warnings

The value of investments and the income from them can go down as well as up and you may not get back the amount invested. Past performance is not a guide to future performance. The details contained here are for information purposes only and do not constitute investment advice or a recommendation or offer to buy or sell any security. The information above is provided on a general basis and does not take into account any individual investor’s circumstances. Any views expressed are those of LGIM as at the date of publication. Not for distribution to any person resident in any jurisdiction where such distribution would be contrary to local law or regulation.

 Issued by:

Hong Kong: Legal & General Investment Management Asia Limited, a Licensed Corporation (CE Number: BBB488) regulated by the Hong Kong Securities and Futures Commission (“SFC”). This material has not been reviewed by the SFC. 
Singapore: LGIM Singapore Pte. Ltd (Company Registration No. 202231876W), regulated by the Monetary Authority of Singapore (“MAS”). This material has not been reviewed by the MAS.