In the first part of this Insurance Asset Risk / Russell Investments roundtable, insurers discuss their views on the COVID-19 impact on asset valuations, credit considerations and how they approached Q1 and Q2 turbulence in their private market investments.
Adrian Chapman - Group ALM Manager, Legal & General
Ankit Shah - Head of Investments and Treasury, QIC Glob
Carolyn Tsalos - Director UK Institutional, Russell Investments
David Walker - senior staff writer and head of projects, Insurance Asset Risk
Jayen Madia - Head of Risk Assets, Axis Capital
Leigh Hazelton - Research Analyst, Private Markets, Russell Investments
Manuel Dusina - Director, Infrastructure & Energy, Scottish Widows
Prasun Mathur - Private Assets Lead, Aviva UK
Simon Blowes - Investment Manager, ReAssure
Chaired by Vincent Huck - Editor, Insurance Asset Risk
Vincent Huck: Can you share your thoughts on how you have dealt with the turbulence in Q1 and Q2 and, in regard to private market investments, what has been particularly challenging?
Manuel Dusina: We started the year with a decent pipeline, based on last year's conversations and track record, and then all of a sudden the virus came and started to affect the execution. I would say that the main point was really pricing. For us to justify an investment from a private debt perspective, we need to lock in an illiquidity premium. But from mid-March onwards, until the end of April, there was a widening of all the indexes, so it was very difficult to actually price a transaction or be able to hold pricing based on the levels 'pre-COVID'.
That has put a lot of transactions on hold and that has affected timelines and appetite, because credit considerations also came back into the picture.
It is important also to mention that the oil prices were negative at one point [in May], which also contributed to the market being very volatile.
We see some signs of stabilisation now. At least the market seems to have found a new sort of equilibrium. We are rebuilding our pipeline, and we see transactions coming back to market, but all of them have repriced.
Simon Blowes: We have very much faced the same problems with pricing and we are also very much focused on locking in that illiquidity premium, so if there is little stability in the corporate credit indices, it is very difficult to pin down what that illiquidity premium is.
The other challenge we have had to face is the lead times involved when originating a private debt asset: you may agree a certain spread at a certain date but the transaction may not fund for another month or so.
Now, in a month or so in markets in times like these, a lot can happen to the corporate credit indices or whichever benchmark you may be using, so initially you may think you have a pretty attractive illiquidity premium, but when it comes to pricing/funding date, you may find that that premium has evaporated.
We have been asking some asset managers if the market should rethink the way that these assets are priced in order to reduce spread volatility risk during the underwriting process. If, for example, the loans should be priced to a benchmark or basket of bonds, so that the illiquidity premium is locked in through to the pricing date.
Manuel Dusina: Some of the asset classes that we were looking at pre-COVID are more exposed than others, so we have to reconsider which asset class we will look at again now, and potentially look at changing the structure under which those assets can be financed.
Airports, for instance, have always been a core infrastructure asset class. But now they are not doing very well, because they are impacted by the number of passengers declining, and some airports are shut. Will airports [investments] return to their pre-COVID levels? Eventually, yes, but which airport will you pick? There will be winners and losers, so there is also a scrutiny of which sectors you will still target or will downsize.
Jayen Madia: One of the themes we saw in March was that private credit and private equity players reconnected with the public markets, because the private markets bid/offers were too wide, or there was no liquidity. So we have seen private equity firms buy their favourite stocks in the public markets, and we have seen private credit firms focus on structured credits, CMBS, CLOs, and we have seen private real estate loan originators buying single assets, single-borrower CMBS. That is where the opportunities seem to have been, in March and April.
As everyone knows the private markets move a lot more slowly than public markets, so marks for the March quarter for a lot of fund managers have been somewhat muted. Unless they had some type of tie to the public markets, where their valuation firms could mark their positions down, a lot of them have maintained 'sticky' marks.
It is going to be probably three or four more quarters before we really understand where the losses are going to be on the private side.
Prasun Mathur: The pipeline has certainly shrunk post-COVID and pricing is certainly being renegotiated post-COVID. For credit, we are re-underwriting every credit post-COVID and reassessing what we want to focus on. There are certain sectors more impacted than others, and if we had transactions on the horizon for those sectors, we are reassessing our medium/long-term appetite ahead of going through with transaction due diligence.
That has all had an impact on how much we can invest, and deploy capital in the private markets. We have increased our focus on public markets and the different kinds of variety of public credit that we can invest in. We have started taking a deeper look into liquidity in the public markets, and the transaction costs of deploying larger amounts of capital in public markets, to actually truly assess relative value between public and private, and try to make use of opportunities in the market where we think that, net of transaction costs, we can actually deploy capital much more efficiently on the public side than private side.
Our focus has largely still been on fixed-income, because we are primarily fixed-income investors. We have seen opportunities emerge from the banks, where they might require funding for different reasons. That has created further options for us to deploy capital efficiently.
We have reduced focus on selling corporate credit to buy illiquid credit and we have increased focus on new business money deployment, which is coming primarily from gilts and cash and from new liabilities that we originate.
Looking forward, I see June as quite crucial. It will tell us what the rent rolls have been, and whether our commercial property based investments have been affected.
Vincent Huck: Adrian, is the month of June critical for you, too?
Adrian Chapman: In relation to commercial real estate, a lot of the support in the UK from the government has focussed on corporate tenants. There has been a lot of work ensuring the discussion between corporate landlords and corporate tenants is balanced to ensure support is there for both.
Ankit Shah: Certainly we did see some good opportunities in March and the early part of April in liquid markets. We found opportunities in Corporate IG space as well as alternative liquid assets such as securitised CLOs. We have been looking at some of the special situations fund strategies arising from recent opportunity, where usually long-term issuers are starting to issue shorter durations.
Vincent Huck: Leigh, is the view any different from the 'other side of the net', from the asset management side?
Leigh Hazelton: In terms of deploying our capital, the key focus in our team is making sure we are lining it up appropriately, which ties in with how quickly public markets have dropped then rebounded. Who is to say whether or not we will have another down swing? We have seen quite volatile movements in public markets, and that has created dislocation in value.
We are lining up our capital to make sure that we can deploy it into strategies that can take advantage of that. If we look at real estate, for example, historically there is often a lag of six to nine months between REITs and unlisted real estate, so the distress and the dislocation in that market is more likely to hit in Q3.
In terms of rent collection, there is quite a variety of outcomes, depending on the sector, with the obvious laggard, at the moment, being retail.
In Europe, for example, March and April rent collections were only about 50% of what you would expect, and unsurprisingly, that is where most of the deferral requests are coming through. But even in offices, for example, we are still only seeing 80% of the rent collected. It will be interesting to see how the valuers treat the lower levels of rent collection.
We have heard certain managers mention that in some instances, the valuers may just assume that the missing rent is never collected and is completely lost, which is quite draconian. We are going to see different approaches taken in commercial real estate.
Jayen Madia: One of the trends in commercial real estate over the last few years has been the rise of the industrial sector, versus the decline of retail, which everybody knows about. COVID-19 has dramatically accelerated that trend, and the divergence between the two has accelerated. The industrial real estate players are trading at all-time highs.
David Walker: Given that insurers' claims burdens are radically uncertain at the moment, is there any pressure or talk of holding off from investing, to make sure insurers can cover claims.
A second question is on diversification. If some of the sectors are very uncertain or not favourable for you, can you still diversify private markets portfolios enough, or has that challenge risen as a result of COVID?
Manuel Dusina: Margins may widen, so you may think that because a margin is higher, you make an overall higher return, but on the other hand all the risk-free [assets], like gilts and Treasuries are actually trading at record lows so offsetting the increase in margin.
It is challenging to win new annuity business, because you need to assume a return when you acquire liabilities and then transfer them to our balance sheet, and then you need to source assets to match those liabilities and meet the assumed return. This is more difficult with increased volatility.
The bulk annuities market was supposed to set a record for volume this year, but we have seen a little slowdown, because everybody is trying to reposition and see if it actually makes sense to make the transfer now, or maybe wait until the market normalises. All the central banks' actions are not incentivising them to make that move, with interest rates reaching new record lows.
With regards to liquidity, we keep significant reserves in cash or gilts or equivalents, so we will never have a problem to pay out pensions. However, we may take some small credit losses, but that really depends on how long the COVID-19 situation remains. Hopefully, by the end of June, July, or the end of this year, things are regularised, and then that would be fine, but if difficulties are prolonged, and more waves of the virus may come again, that then is a new game and some of our borrowers may struggle.
Jayen Madia: Actually, we have seen a fight for liquidity nowadays in private credit. Borrowers have drawn on their revolver capacity, whether they need the money or not. Revolvers have been drawn to the tune of over 50-60%. Fund managers have drawn on their capital commitments, subscription lines have been drawn and so, everybody is fighting to make sure that they have enough liquidity. It is most pronounced in areas where there is an asset/liability mismatch.
For example, some of the commercial mortgage REITs are down very severely, and having to sell assets at the bottom. The repo financing and the asset/liability mismatch that has existed within the private credit industry is something that might be a fundamental change going forward and coming out of this crisis.