Is It Time for Insurance Investors
to Consider Including Systematic Fixed Income in their Portfolios?

We recently conducted a Q&A with Paul Benson, Insight's Head of Systematic Fixed Income, on the potential applications of Systematic Fixed Income approaches within insurance portfolios.

Paul Benson, CFA, CAIA | Head of Systematic Fixed Income | Insight Investment
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FOR INSTITUTIONAL INVESTORS ONLY. NOT TO BE DISTRIBUTED TO RETAIL CLIENTs. This strategy is offered by Insight North America LLC (INA) in the United States. INA is part of Insight Investment. Performance presented is that of Insight Investment and should not specifically be viewed as the performance of INA. Please refer to the important disclosures at the back of this document.

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SAA: First things first, what is systematic investing and how may a strategy differ from a traditional approach?

Paul Benson: We see it as a rigorous, mathematical rules-based approach to active management. So, its “quantitative” rather than “discretionary”, which perhaps describes more traditional strategies that feature some level of a qualitative approach.

Quant approaches operate according to a well-defined system that we can execute technologically using computer programs.

That said, there are many ways to skin a cat, and other managers may see things differently. For example, some systematic approaches use what they call a “quantamental”, approach which is a mix of quantitative and discretionary. We are more purist about things, preferring something closer to a fully quant approach that takes all the “emotion” out of investment decisions.

We and our clients see systematic investing as a complement to their discretionary investment portfolios as it can lead to different-looking portfolios.

But the beauty of computers is that they are tireless and can operate close to light speed. So, if we can construct a model to analyze a bond, we can run it repeatedly and quickly across an entire universe. So, our strategies typically take more numerous and more diverse alpha positions than most traditional strategies, which tend to focus their alpha positioning on a more limited sample of credits that a manager has the resources to hire credit analysts to cover.

This difference in approach also tends to allow for a high degree of diversification. Our broad high yield strategy, for example, has had an alpha correlation of less than 0.25 with 90% of the fundamental active US high yield manager universe and a negative correlation with 60% of it.

SAA: Systematic strategies have been common in equities, why have they only come to prominence in fixed income relatively recently?

Paul Benson: It really comes down to liquidity. You can trade equities at a penny-wide spread, making it easy to set up a model-based approach. But in bonds, OTC trading is expensive.

However, the rise of fixed income ETFs has changed the game. We developed “credit portfolio trading” across both investment grade and high yield markets. Instead of trading bonds one at a time, credit portfolio trading involves trading “baskets” of bonds, potentially 500 or 1000 at a time, with ETF counterparties that are tightly integrated into the ETF ecosystem.

Which in our experience lowers global investment grade transaction costs from around 30bp to 20bp and US high yield transaction costs from around 60bp to as little as 15bp. An additional benefit is that this can allow us to receive the “illiquidity premium” embedded in high yield credit spreads for “free”, given we find we can trade them fluidly and efficiently.

Our high yield strategies often hold over 90% of bonds in a high yield index, whereas most traditional active strategies hold only 15% to 30%¹.

We find we can transact $500m per day, generally executing within minutes or hours. We find a trade can be as large as $500m or as low as $5m for exactly the same diverse basket of bonds. Therefore, portfolio trading is accessible to insurance companies regardless of size of balance sheet.

¹eVestment US high yield fund universe from April 2013 to March 2023, Insight calculations. Past performance is not indicative of future results. Investment in any strategy involves a risk of loss which may partly be due to exchange rate fluctuations.

SAA: What benefits does systematic high yield offer for insurance companies?

Paul Benson: As we know, insurance companies have lots of constraints and unique requirements.

For our high yield ETF strategy, we engaged the SVO to receive NAIC designations. Typically, ETFs are treated as equities for regulatory reporting purposes, but an NAIC designation often allows clients to treat them as bonds for regulatory reporting purposes, given the underlying assets are bonds. For us, it was important to make the strategies as investable as possible for insurance general accounts.

Having said that, in some states an NAIC designation may not be able to classify ETFs in a capital-efficient way. But we can achieve the look-through for regulatory capital purposes through separately managed accounts.

Separately managed accounts also often work for our clients because, while ETFs constrain investors to a certain benchmark, separately managed accounts can be customized. And I think one of the main benefits for insurance companies is how customizable systematic strategies are.

Ultimately, our models are benchmark-agnostic, so we can really rely on our clients to tell us what their constraints, concerns and desires are. For example, we have international insurance clients whose capital penalty is highly correlated to duration. So we can target a portfolio of high-yield bonds concentrated in maturities of less than three years. Or if there's a similar client that has an aversion to CCC bonds, we can construct a double-B and single-B portfolio that is highly diversified. We're not tied to the strengths of our credit analysts.

We are seeing more and more clients embrace systematic approaches for both strategic and tactical allocations.

On the strategic side, many are sensitive to gains and losses, prioritizing income and capital preservation. So many clients use our strategies as strategic income generators. Because we can build highly diversified portfolios, defaults are less of a concern for us than they might be for more traditional managers, so we perhaps have a greater ability to embrace default risks where we think credit spreads offer ample compensation for the risks.

Tactically, we increasingly have clients using our systematic high yield strategies to dial risk up or down efficiently based on either their risk-based capital position or to take advantage of tactical opportunities. Insurance companies are certainty no longer the “sleepy” investors that is often dictated by the stereotype, but to be tactical in high yield, you need a high degree of liquidity so that you can move assets quickly. You need to be very watchful about transaction costs, so that you don’t leave behind the alpha on a large tactical move.

Insight’s team has been managing insurance assets for more than 30 years. We have watched them evolve as the investment opportunity set has expanded. Our clients can benefit from open access to an extensive pool of investment professionals including portfolio managers, research analysts, actuaries and solution designers. We like to work in partnership with our clients and strive to be an extension of their team.

Source: Strategic Asset Alliance, Insight Investment. The information contained herein has been obtained from sources believed to be reliable, but the accuracy of information cannot be guaranteed.

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