Insurer Pioneers New Model for Investment Delegation
Amid the trend towards outsourced investment models such as fiduciary management, outsourced CIO (“OCIO”) and implemented consulting, Coface has developed a different approach – one that lets this insurer delegate resource-intensive practicalities while retaining meaningful investment control. “We still want to be the driver of the car,” says Jean-Philippe Olivier.
Q: What were your key aims when developing Coface’s approach to outsourcing investment capabilities?
Three questions were key for us. One: what is the best way to use our team’s resources, given our relatively small size compared to other institutional investors? Two: how can we maintain responsibility and autonomy, in a way that would not be possible with fiduciary management? Three: how can we develop something that is flexible, allowing us to use whatever asset managers we wish, with the capability to evolve through time?
Keeping some control is very important indeed for us – not just as an investor but as a PNC insurance company. We have to think about the portfolio and how it adds value on a long-term basis because our investment results make a significant contribution to the global P&L – the returns can represent 30% or even 40% of the firm’s total financial results for the year.
You can delegate asset management, with fiduciary management for example, but it is very difficult to delegate risk appetite or risk sensitivity – especially the sensitivity of the firm, the chairman or the CFO to a drawdown in markets. Who really has the responsibility to define if it makes sense or not to support a drawdown in equity markets of 10-20%? That decision will depend on many factors and the various issues facing the firm at the time. At the end of the day the responsibility for that decision has to remain with the client. Setting a risk budget is not enough. It can be very uncomfortable to consider the reality, which is that an external asset manager may succeed in delivering on their mandate but be producing a result which is not best for the client.
There are also particular circumstances where we may need to become active, and it’s important that we can do this. For example we as a business could have an issue relating to a specific emerging country but an asset manager may still want to invest in that specific market. Although it is practical to delegate a lot of asset management responsibility we wanted to keep the ability to control this type of situation. If we want to sell one security or one type of exposure we can; if we want to hedge a part of the portfolio we can. We still want to be the driver of the car, considering our liabilities and business risks.
The aim, in short, was to have the best of both worlds, with the flexibility to intervene or be hands-off depending on timing and our specific internal issues.
Q: What did the investment portfolio look like before the adoption of the new model? What needed to change?
It probably makes sense to think about this in terms of two subjects: organisation and investments. While investment returns and organisation/cost are both very important, one could say that the latter has a disproportionately high importance for small and mid-sized investors. Coface is a medium-sized investor – about €2 billion at the time and around €2.8 billion now – meaning that our capacity to absorb a lot of cost is not substantial.
From an investment standpoint we had a large portfolio of domestic bonds, money market investments and a small allocation to equities. Yet we did not have a consolidated view for all our entities in terms of asset allocation – we have more than 20 insurance entities around the world, since we are a very global firm. We also had a lack of tools with which to do important things like stress testing, P&L monitoring and assessing real-time basis risk exposures. At the time we had fewer than ten people for investment management, accounting, local and global reporting, regulation reports, internal stress tests and so forth.
Cost was a key obstacle to solving these issues. Asset management fees are only one of the expenses to consider: we need recurrent tools for accounting projection results, risk, regulatory compliance and more. What we wanted to do was find a way to use external tools for these tasks, at the cost of a few basis points per year, rather than having to build our own and maintain them continuously.
Although the team was not large, we did manage some investments internally, in equities and domestic bonds, and had appointed three external managers for specific asset classes. Today we still have a mix of in-house and external management: our new model enables us to keep some things in-house but use the outsourced platform for the reporting and risk management. The question of what to manage in-house and externally can change, to some extent, depending on the investment conditions and the value-add expected. For example, it’s not too difficult to manage domestic bonds internally when you have 4% coupons but the situation changes when you have very low rates and have to think about diversification, private markets and a broader universe of government and corporate bonds. Right now I wouldn’t want to delegate French or German domestic bonds to an external manager for example. You’ve also got to think about capability: is it really possible to add value in equities if you’ve got only one or two people managing a portfolio internally, as we did before?
What was your experience in searching for an asset manager to fulfil the role you wanted? How do they work alongside the other asset managers you use?
One principle was very important to us: we wanted a Chinese wall between the global asset manager advisor and the other asset managers who we select for dedicated mandates (we call them “delegated asset managers”).
We made it clear from the start that we were looking for a global firm but that we wouldn’t be expecting them to manage the underlying funds apart from specific cases like transition management or back-up functions. We were looking for advisory and resource – access to systems, tools, reporting, portfolio-level support such as currency hedging and so forth. That’s all we wanted to pay for. Meanwhile we pay management fees to the delegated managers. It’s not hugely profitable for the global manager partner in the short-term, but over the long-term the costs can be amortised and things become more efficient. Yet we also made it clear that, over the medium and longer term, there may well be some opportunities for the partner to take on delegated mandates as well, especially since we envisaged a simplification of the global scheme over time.
It’s important that the advisor manager partner does not advise alone on the selection of the other managers, even though the firm we chose (Amundi) does have multi-manager capability. We want very clear independence on this point and choose the right process on a case by case basis to ensure that decisions are unbiased and unconflicted. We can use our own resources to select managers, or we can use external advisors to help us with this.
One reason that we particularly liked Amundi for this partnership was that they created a dedicated Coface team at the organisation which has always been committed and available throughout the project and as the platform has evolved. This is very helpful indeed – we feel well-supported.
Q: What has changed since the platform was first introduced? Are you happy with the results?
There have been four significant changes since we introduced the new model, each of which really demonstrates the flexibility that it provides. Firstly, we created a new reinsurance company in Switzerland a couple of years afterwards. This was very complicated as we had to address many operational and local constraints. We essentially had to build a second platform at Amundi (for Switzerland) with the same services as the first (France and Global), and a third platform to oversee the other two platforms! You can imagine what it’s like going to an advisor after two years and saying ‘thanks very much but now we have to make major changes’! They dealt with it very well.
The second change was the addition of new asset classes: real estate, both debt and equity. That was quite challenging in terms of reporting, monitoring and solvency calculations, but the model handled the change well. The third development, which is in progress now, is the significant change to our accounting rules for the implementation of IFRS 9. This has a direct impact on asset management and valuations.
The fourth change is particularly interesting, perhaps. We have been seeking, step by step, to include our own insights and inputs into the platform, particularly in areas such as developing our asset liability management framework. It’s actually very difficult to determine, for example, what the right level of risk assets should be. Risk appetite, as noted before, is a very complicated and nuanced subject. It is important that we have a contribution here.
All in all, the last four years have really demonstrated the value of this approach. We still think this is the best scheme for us and are likely to renew when the time comes for us to do so.
Q: What about your own role? How has it changed?
With only a few people dedicated to investments in-house, we continue to be very present and active in daily contact with our dedicated team at Amundi and in regular meetings with asset managers and peers.
It is a great mistake to think that if you delegate asset management responsibilities you don’t need to have high-quality people in-house. Some CIOs fear outsourcing because they fear what it might mean for their job. They wonder: would I have a role, or would my role be less interesting? Yet in fact I personally think the opposite is true. You need people in-house with wider skills across investments, risk and strategy. You need people who can scrutinise the asset managers, challenge them properly, understand their investments and allocations. When I joined Coface in 2013 [from the French public pension reserve fund, FRR] they were planning to outsource and really understood the importance of having key senior people in-house.
As investors weigh the potential advantages and disadvantages of outsourcing, we look forward to seeing how innovative approaches which keep the investor and stakeholders in the driving seat fare alongside more conventional investment delegation models.
Disclaimer: bfinance is a provider of manager selection services to Coface.
This commentary is for institutional investors classified as Professional Clients as per FCA handbook rules COBS 3.5R. It does not constitute investment research, a financial promotion or a recommendation of any instrument, strategy or provider. The accuracy of information obtained from third parties has not been independently verified. Opinions not guarantees: the findings and opinions expressed herein are the intellectual property of bfinance and are subject to change; they are not intended to convey any guarantees as to the future performance of the investment products, asset classes, or capital markets discussed. The value of investments can go down as well as up.
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