Euro insurers switch negative yields for emerging debt
By Tom Arnold and Karin Strohecker
LONDON (Reuters) – European insurers are snapping up more emerging-market debt, spurred on by worries that negative-yielding bonds in Europe might not offer enough returns to meet their future payments.
The move represents a shift for investors, who have usually filled much of their portfolios with high-grade bonds issued by developed-market governments and companies.
An estimated 250 billion euros, or around 5% of European insurers’ assets, are invested in fixed income, up from 2% to 3% five years ago, said people at several insurers.
Signs of the shift can be seen in their participation in recent euro-denominated debt issues by countries like Ukraine, Indonesia, Saudi Arabia, Romania, Croatia, Serbia and Egypt.
Roadshows for Saudi Arabia and Ukraine attracted German, Italian and French insurance businesses not previously active in emerging markets, a person involved in both issues said.
Euro-denominated issues make up less of the hard-currency market than issues denominated in U.S. dollars, but European insurers have a natural bias toward such debt. It eliminates foreign-exchange risk and capital charges for holding assets outside their home currency.
“Emerging-market hard-currency bonds offer a valid alternative in terms of risk-reward to euro zone core and periphery bonds,” said the head of the asset-management arm of a leading European insurer who asked to remain anonymous.
“We’ve sold some BBB European credit we’ve held and added instead emerging-market exposure of the same rating.”
Faced with evaporating euro zone yields — the German yield curve has tumbled to sub-zero in its entirety for the first time on record — European insurers have turned to investment-grade emerging-market fixed income.
“Investors are engaging in a hunt for yield, which leads to increased demand for emerging-market debt, which offers attractive yield relative to other asset classes,” said a spokesperson for Allianz (DE:ALVG) Global Investors, which manages just over 200 billion euros of the 571 billion euros in assets held by insurer Allianz Group, its parent company.
The European Union’s “Solvency II” rules allow insurers to apply similar capital charges for hard-currency securities with comparable ratings and maturities, regardless of whether the issuers are in developed or emerging markets. But emerging-market bonds tend to offer a higher return.
Investing in emerging-market debt is not without risk. The higher returns on emerging-market assets exist to compensate for more volatile and less liquid securities than in developed markets.
“Insurers will be subject to the same risks as any other investor in emerging-market debt, so volatility and liquidity will be of concern,” said Henry Dean, an associate at Eversheds Sutherland.
As a result, many favor investment-grade emerging-market debt – a bulging market in recent years as countries from Peru to the Philippines clean up their current account balances.
“The emerging-market universe has grown substantially over the past decade, and with it the number of countries and issuers in the various regions we need to monitor and see investment opportunities in,” said Iva Alexandrova, portfolio manager at AXA Investment Managers, AXA’s asset management business.
Some insurers are venturing beyond investment grade, even adding local-currency government bonds, where liquidity and FX risks tend to be more pronounced.
European insurers can invest in high-yielding debt, but at the cost of some impact on their coverage ratios, which measure their ability to service debt and meet financial obligations, said Marcelo Assalin, head of emerging-market debt at NN Investment Partners, the asset-management arm of insurance and financial corporation NN Group.
Emerging-market hard-currency debt has offered an average annual yield of around 6.3%, almost twice that of U.S. investment-grade debt since 2016, when many insurers began focusing more on the segment.
(Graphic: Emerging market investment grade spreads vs similar U.S. credit link: https://tmsnrt.rs/2MIHNXY).
Some say the relative risks associated with emerging-market debt are diminishing. The average monthly default rates over the past decade for emerging-market hard-currency high-yield bonds stand at 3.03, compared with 4.06 among high-yield U.S. bonds, according to Aperture Investors, a new boutique asset manager part owned by Generali (MI:GASI), whose inaugural fund focused on emerging market assets.
Debt levels among investment-grade developing governments and firms have fallen since 2017, AllianceBernstein says. Market volatility has eased, though uncertainties about global growth could revive that.
“Our core thesis is based on an expectation that the yield environment will continue to be supportive of credit markets, so we’ve been advocating building a positive carry structure for insurers, and we think emerging markets is an important part of building that,” said Peter Cornax, portfolio manager of AllianceBernstein’s global credit strategies, who counts several European insurers as clients.
“BB spreads have actually compressed significantly to BBB credit, and the emerging market has a more bulleted maturity structure than the high-yield market.”
That’s important for insurers needing to match their assets against a timetable of maturing liabilities.