On March 22, 2018, John Mohr, Managing Director & Principal, SAA, moderated a panel at the Insurer Investment Forum XVIII with Vanguard Institutional Investor Group and State Street Global Advisors – SPDR to discuss the current state of Fixed Income ETFs in the insurance space.
Head of Insurance General Account Solutions
Vanguard Institutional Investor Group
Head of Insurance ETF Business Development
State Street Global Advisors – SPDR
Here are a few of the highlights:
John Mohr, Managing Director & Principal, SAA:
Who do you see as the big users, over the last year or two, of Fixed Income ETFs?
Kelly Sweppenhiser, Head of Insurance General Account Solutions, Vanguard:
Focusing on the insurance side, there’s roughly $20 billion invested in ETFs throughout the statutory landscape for insurance companies. Breaking that out it’s roughly 75% equity, currently. Those dynamics are changing. $5 billion is invested in fixed income ETFs today: About half of that is Life, 40% is P/C and the other 10% in Health.
Marc Mercurio, Head of Insurance ETF Business Development, SSGA – SPDR:
That $20 billion is based off year-end 2016 statutory filings. If you look at the interim filings, which are slightly less reliable than year-end filings, we have seen a big jump in Fixed Income ETF usage. We would expect that $20 billion total to jump to $25 – $27 billion when we get the year-end filings. A Strong big growth of, about $3 – $4 billion, on the fixed income side.
JM: Are there other investors using fixed income ETFs, besides insurance companies?
KS: If you look at the overall ETF landscape, it crossed over $3 trillion last year. Approximately $650 billion of it is now fixed income. The biggest advocates that we (Vanguard) have seen on the fixed income ETF side would be more of the traditional advisor platform solutions; think of Merrill Lynch, Morgan Stanley, UBS. Also, what we consider “mega” RIAs and robo-solutions. There’s a lot of different areas in the institutional market in the space and we’re really in the early days for the insurance space.
JM: Obviously with an ETF, some insurance companies might be buying them directly or have an asset manager use them. Do you have a sense for how it’s being used more?
KS: The answer is “direct.” Some of the more traditional asset managers leverage ETFs in their portfolio solutions, but its more so the internal investment teams that are adding ETFs to their portfolio than coming from the outside.
MM: We have spoken to a number of traditional insurance asset managers on the fixed income side. Some are more open to using fixed income ETFs than others and the biggest impediment has been the investment policy statement issues. How do I classify an ETF? What ETFs are appropriate within my fixed income mandate? What kinds of limits should I impose? Those are the types of issues that take a little longer to work through a 3rd party manager than an in-house investment team.
JM: You mentioned “Investment Policy Statements.” Some states view ETFs in different ways. With that in mind, how are they using them? Are they using ETFs to invest entire fixed income portfolios based on a broad market benchmark? Is it sector specific? What’s the use-case?
MM: The most common I would point to the cash in the general account portfolio; that cash needs to be invested. Typically, the portfolio manager is looking to allocate to new issues or looks into the secondary fixed income market, but that can take some time. Traditionally, what insurers would do is hold US Treasuries, so they would at least have that interest rate duration.
Instead, what we’re seeing is portfolio managers using a fixed income ETF to capture that spread duration as well. Another example is more on the treasury side. Some insurance companies, because of the way their claims turnover quickly, hold a lot more cash within the treasury team. We’re seeing fixed income ETFs utilized as secondary way source of liquidity where they can get a little more spread. Every insurer is fighting for every basis point they can. Another way I’ve seen would be “Opportunistic Plus Sector Exposure” from small and large insurance companies. It can take some time to select high-yield bonds that you want, but if you see an opportunity (i.e. spreads blow out), using ETFs is a very liquid, efficient way to get that high-yield exposure. A fourth example I’ve seen is subsidiary portfolios.
A lot of insurers have $10 – $30 million subsidiary portfolios and for legal reasons have to be segregated from the overall general account portfolio. At that size it’s difficult to transact in cash bonds. We’ve seen some insurance companies build subsidiary portfolios exclusively of fixed income ETFs, where they mimic the duration, yield and spread of general account portfolio. They use ETFs to do that so they’re not constantly having to transact within the smaller portfolios.
KS: I would add “manager transitions.” During the transition of a new manager, what do you do with the portfolio in the interim? You have a strategic asset allocation; you know you want a certain exposure. A fixed income ETF is a great place to do that.
One of the other intriguing ways is on the property & casualty side during M&A talks. Some insurers are one morning away from coming into the office to have their CEO tell them, “I need $100 million; we’re buying a company.” That’s a real situation for many P/C companies at some time in their business lifecycle. There’s a pretty big, immediate cash need. The last thing you want to do is sell a chunk of the core fixed income portfolio. We’ve been having conversations more and more about “buffer portfolios.” Where you have a little bit of area where you are willing to accept more beta exposures for your strategic asset allocation. It may only be 5% or 10% of the overall portfolio, but it’s that buffer between having to ask your manager that you need to raise cash when the alpha ideas aren’t able to be realized.
JM: We’ve had clients that have used ETFs to gain exposure temporarily or as a cash buffer. For smaller portfolios, where we can’t utilize that active management on the fixed income side. And then as a temporary asset allocation until we do a full asset allocation study. For insurers that are regulated, states view ETFs in different ways. How are you handling that? What are you seeing from different states?
MM: I think we see a true spectrum, in terms of “favorable” to “unfavorable” views on fixed income ETFs. Some states will end up with accounting that looks more like fair-value. Some states are working to modify their regulation to give fixed income ETFs “better than bond treatment.” You get both the capital benefit of the NAIC rating, the accounting benefit and the look-through treatment from the diversification perspective.
JM: Public insurance company usage vs. Private company usage. Is there a big disconnect regarding GAAP or an education process required?
KS: A little bit, but a lot of the public companies are big insurers. They’re not going to be putting $20 billion where it creates an actual ripple effect on their ultimate capital floor. It tends to be one of those underlying sub bullets of the portfolio strategy and doesn’t even hit the radar with most regulators. For the smaller public companies, they tend not to be users. They don’t want to have that conversation. Let’s be very clear, this isn’t for everybody. Whether it’s public perception or overall strategy, sometimes you just shake heads and you both realize it doesn’t make sense.
JM: Any insight on ETF usage amongst Government Risk Pools?
KS: It is growing. Government risk pools tend to be smaller than the statutory players that we talk to. So, we do hear anecdotally. For mutual funds, we generally know who is using our products as the transaction is between Vanguard and the end buyer. Whereas ETFs they’re done through 3rd parties and brokers, we don’t typically know who the end user is. We don’t have a way to track that for pools, unless anecdotally.