As a consequence many European companies are taking the dramatic step of handing responsibility for asset management to external providers.
The question of whether to outsource asset management is one dividing the life insurance industry. As the debate rages, asset managers hungry for new business are hoping the question will be answered with a resounding yes.
The case against outsourcing is strong, however. “Outsourcing is not able to cope with complexities of an insurance company”, argues Joachim Faber, chief executive of Allianz Global Investors and member of the Allianz’s group’s management board. He says that fund management is so central to the life insurance business that it must be kept within the company’s four walls.
“The insurance company has two streams of income: the results of underwriting and income from investments, so the latter has to be taken really seriously. Outsourcing means you hand over a sliver of the portfolio to a fund manager, who runs it as a relative return mandate. A typical relative return mandate cannot satisfy the needs of an insurance company.
“You have to look at realised and unrealised gains and combine this with the requirements of IFRS accounting standards. Therefore the turnover of a relative return mandate is a problem. You need to be able to oversee asset allocation and look through the portfolio to each underlying holding in order to match the investments to the liabilities.”
Vital ingredients
To succeed you need a fairly formidable in-house asset management operation, admits Dr Faber. “What happens if you proudly build your in-house department of 30 people with their experience of UK equities and global bonds, and then you come to the conclusion that what you need to invest in Asian equities and hedge funds?”
The Allianz strategy is to “build a reasonably large asset management company in-house”. This has resulted in a veritable spending spree, with Allianz buying up companies such as global bonds giant Pimco, which provides access to the full range of fixed income strategies, from real return bonds to emerging market debt. It has also bagged companies like Oppenheimer Capital and Nicholas Applegate, which cover the gamut of regions investment styles and market caps.
“We acquired US managers particularly because they have the most advanced techniques,” says Dr Faber, “we wanted a breadth of expertise that we could apply globally. We didn’t want to be the big German asset manager who just gathers more and more assets.”
The global application of bought-in expertise is already in action. For example, Pimco has begun applying the techniques it uses to run its successful total return dollar product in Europe and Japan.
Amanda Forsyth, investment relations director at Standard Life, shares similar views. “We still regard asset management as an absolutely core skill. In terms of investments we are a powerhouse. It’s not just a function that sits to one side.”
She adds that Standard Life’s in-house team have no problem keeping up with the latest innovations in the investment community and they are able handle specialist asset classes, such as private equity. “We are constantly re-evaluating the various products out there in the market. We would buy in any expertise we needed but didn’t have, so I can’t see the logic of outsourcing.”
She underscores the strength of Standard Life’s asset management capabilities. “We have set up a global network of fund managers who we bring together to discuss what’s happened in the marketplace. In this way we pull in global expertise from different asset classes into a centralised system of company meetings.”
But not all companies can afford to buy-in such expertise. Those in favour of outsourcing argue that it can be a cheaper way of working. State Street Global Advisors is among the fund managers offering to take the business of investment management off the hands of life insurers. Chief investment officer Rick Lacaille says outsourcing can pay off – especially for smaller firms or those with complex investment portfolios – by removing operational costs, such as the need to build and maintain middle office risk compliance systems.
More importantly, he says, life insurers may be able to access products they would not otherwise have been able to. Opting to outsource to a multi-manager, such as State Street, can mean your assets are pooled in a larger institution which has more clout when it come to getting into certain funds, such as exclusive private equity products.
Maintaining control
Mr Lacaille refutes the notion that outsourcing means losing control of an important part of the life insurance business. “You have to ask what sort of control have they lost. The most important thing for life insurers is to get a grip of asset/liability risk. I can see why they would want to stay in the driving seat on that front.
“When it comes down to the securities level, the fund manager will have to stay within the guideline set by the insurer. These would be at least binding as the guidelines they would set for an internal asset management team and usually much tighter.”
Mr Lacaille, speaking at an FT Business conference at the London Stock Exchange, argued that external providers are able to handle the complexities of life insurer clients. “When you’re looking after these clients you have to be sufficiently flexible to offer a wide range of products and respond at quite short notice to requirements. From a legal perspective, we need to understand the environment they are working in. They are a little bit ahead of pensions in terms of asset – liability risk, potentially a little more advanced, so we encourage the use of swaps, options and other instruments aimed at controlling risk.”
James Bevan, investment chief, Scottish Mutual and Scottish Provident, makes the case for taking the plunge. “Outsourcing doesn’t take away your responsibility for risk, we still have full responsibility to both shareholders and policyholders.” When you have an in-house team, taking the decision to outsource “can be an emotional issue” but it is vital to stay focused on what best serves those shareholders and policyholders. “It’s a business reality that no job is for life and you have to keep changing to stay competitive. When you think about the little old lady whose life contract is on the line here, this is not a situation where you can protect people who don’t deliver.”
But he warns that “outsourcing will only work where there is real clarity on what’s required.” Clear briefs must be established on both the investment mandate and the process of setting it up. “There are no free lunches is this game and whatever you do has a dimension of risk. Outsourcing is not ‘lets wash our hands and say goodbye’. You need to think carefully about who is helpful and who is not in managing assets.”
For instance, he advises caution when allocating large sums to a fund manager. “I don’t think the majority of asset managers have scalable operations, so while they might have had great performance in the past, they may not be able to handle a huge amount of money.”
The arguments in favour of outsourcing are particularly weighty when it comes to asset classes that actually benefit from being run in enormous funds. “Passive management is a scalable operation, half a dozen global players do it extremely well, so I’m not sure why anyone would want to set up such a complex strategy in-house when it can be cheaply plucked off the shelf”, says Mr Bevan.
According to Ned Cazalet, principle of Cazalet Financial Consulting, life insurers are in fact under increasing pressure to re-consider how they manage their assets in the context of their liabilities. Echoing Mr Bevan’s image of the little old lady’s finances hanging in the balance, he says “life insurers are thinking they no longer have the right to run assets.” Soon, not having outsourced at least some of your assets will be “like not having a mobile phone”.
Amanda Forsyth, Standard Life
