Allure of BBB Bonds Grows for Aussie Insurer Battling Low Yields

  • QBE Insurance has increased its weighting toward credit
  • Insurer may boost duration to as much as 2.25 next year

Australia’s biggest internationally focused insurer is fighting against the tide of low bond yields by taking on more credit risk.

QBE Insurance Group Ltd. has already increased the amount of corporate bonds it owns rated just above junk, and it’s looking to lift the share of its fixed-income holdings with such credit scores toward 10 percent, according to Chief Investment Officer Gary Brader, who oversees $26 billion. Two-to-three years ago QBE had “almost nothing” in that BBB range, he said. He’s also increasing exposure to interest-rate moves as part of an effort to reduce a mismatch with QBE’s liabilities.

“It would be a brave insurance company that didn’t have an investment portfolio dominated by fixed income,” Brader said in an interview last week in Sydney. “But that doesn’t mean at the margins we aren’t looking at ways to push back against the downdraft of lower interest rates.”

The yields on about a third of all global sovereign bonds have been dragged below zero by unprecedented monetary easing and that’s spurring traditionally conservative investors such as insurers to take on greater risk to generate returns. QBE is not alone among insurers in suffering from the scourge of low yields, with domestic competitors such as Suncorp Group Ltd. and IAG Ltd. facing similar pressures. In a global survey of insurers’ finance and investment chiefs conducted by Goldman Sachs Asset Management, 39 percent of respondents cited low yields as the greatest investment risk to their portfolios.

Australia’s general insurers saw their combined total return on investments plunge 47 percent to A$2.2 billion ($1.7 billion) last year on the back of falling bond yields, according to a July report from Fitch Ratings.

More Credit

“We have, and continue at the margin, to skew a slightly greater portion of our fixed-income book toward credit, away from governments and money market,” Brader said. “We have also within that started to migrate modestly to lower rating grades.”

The recent pullback in global debt markets and speculation by some that the nadir of the yield cycle may have passed also isn’t deterring QBE from increasing its bond portfolio’s duration. Boosting duration means a portfolio gains more when rates move down, and suffers more when they rise.

QBE has already raised its duration to 1.5 from about 1 a year ago, and it’s looking to lift that to as much as 2.25 in 2017, Brader said. While that does increase the mark-to-market risk of QBE’s fixed-income portfolio, he sees it acting as a counterweight to the insurer’s holdings of equities, which tend to move in the opposite direction to bonds.

Stabilizing Effect

“The introduction of more duration into the fixed-income portfolio actually acts as a stabilizer of the overall volatility of the investment portfolio returns,” Brader said. He also noted that “going longer lowers the organization’s risk, because it’s reducing the mismatch” with the insurer’s liabilities.

In addition to falling bond yields, the Sydney-based insurer is battling declines in the insurance premiums it charges customers and rising pressure on claims costs for its Australian and New Zealand businesses. Net profit in the six months through June fell to $265 million, down 46 percent from a year earlier, and the company is looking to raise the prices it charges customers and tighten policy terms to help improve margins.

QBE’s investment returns are running ahead of its 2.7 percent target for fiscal 2016, with the insurer’s portfolio generating a 3.3 percent annualized gain in the January-to-June period. The insurer has also bolstered its allocation to infrastructure debt and structured credit, and ventured into hedge funds as well, Brader said.

“We’ve incrementally increased the component of the book that’s in growth assets to deliver higher returns,” he said.

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