France: Search for yield drives market
With more than 80% of its institutional assets related to insurance activities, France is a fixed-income-dominated market. In an environment characterised by historically low interest rates, the search for yield through enhanced fixed-income diversification has been the single most potent force at work in the market. Not only is this behind changes in institutions’ long-term asset allocations, it also contributes to the reshaping of business opportunities for third-party asset managers.
These trends are highlighted in our latest annual research report covering the French institutional market.
It relies on contributions from investors who manage over €2.1trn in assets on their own account. Our 2014 panel includes:
• 100 insurance companies;
• 41 pension institutions;
• 60 other long-term investors (including bank proprietary investment books, industrial liability funds, guarantee funds, foundations and associations).
Back to positive inflows
For the first time in history, the French institutional market recorded net aggregated outflows in 2012. As explained last year, this situation was mostly driven by the business development policies at leading bancassurers, which turned away from off-balance-sheet products. In addition, the imbalance of the Agirc-Arrco pension regime led to a meltdown in the long-term reserves held by these institutions. This result is in stark contrast to the endogenous growth dynamics this market has been known for over the past decade – with average net inflows of 4-5% of total assets per annum.
Hopefully, 2012 will remain an outlier in statistical terms as the market benefited from positive inflows last year, driven by an improved outlook for life insurance distribution and a few fast-growing pension institutions, such as ERAFP.
However, it is unlikely that the institutional market will resume its historic growth level. Our projections anticipate a future pattern in the 0-2% range until structural reforms – such as the real development of a second pillar at the national level – kick in. This means that the French institutional market will, by and large, remain an asset-rotation market for asset managers.
The elusive ‘great’ rotation
After 20 years of the great fixed-income bull run, the question of a new asset allocation paradigm was raised by numerous analysts last year. However, the ‘great rotation’ debate hardly resonated in the ears of French institutions, as they have pursued their quest for yield in the fixed-income markets. The following moves are worth highlighting:
• Short-term investments (money market funds) have been reallocated to longer-dated fixed-income asset classes on a large scale. This contributed to the outflow haemorrhage suffered by most domestic asset managers;
• Allocations to corporate investment-grade credit – unanimously perceived as too expensive – slightly decreased in favour of sovereign bonds (in particular securities from European peripheral issuers);
• Fixed-income diversification benefited from significant inflows.
In our definition, fixed-income diversification encompasses all sub-asset classes that do not qualify as euro investment grade. They include:
• International (global, US) bonds;
• High yield (euro, US and global);
• Emerging market debt (local/hard currency, sovereign and corporate);
• Convertible bonds (to some extent); and
• Private debt (loans and private placements).
At the end of 2013, more than €50bn was allocated to these various asset classes. This represents more than 3% of total fixed-income investments. It remains to be seen whether this trend will continue this year with the turmoil in emerging markets and the across-the-board spread-tightening witnessed in the credit segment.
Of course, there have also been some reallocations towards equity markets. In part, this has been due to a realisation that allocation adjustments implemented to comply with the Solvency II Directive probably went too far.
Institutions have used this new room for manoeuvre to re-expose their portfolios to equities, and about a third of investors in our panel committed new money to the asset class in 2013. Most did it the ‘traditional’ way, using actively-managed European or euro-zone equity funds.
Local boutiques have taken direct advantage of this ‘small rotation’ and, as a result, there are now fewer exchange-traded funds (ETFs) in French institutional portfolios. The use of these instruments increased significantly after 2008 as institutions took a tactical view of the equity asset class en masse. This strategy has now receded and we are back to tried-and-tested equity investment practice.
It is unlikely, however, that French institutions will take their equity allocations to levels last recorded in pre-crisis days. Regulatory constraints remain strong. In addition, the profound distaste for volatility is deeply entrenched in investors’ minds. As a result, the question ‘where next?’ is more relevant than ever, should interest rates rise again in the euro-zone. Our analyses suggest more real assets. Alternatives are not yet considered a viable solution, even though they are a more frequent subject of discussion.
Insurance as growth driver
The dynamics of the institutional market in France can be summarised in accordance with the following equation – insurance market plus low interest rates equals search for yield and therefore further fixed-income diversification. This allocation trend is driving increased outsourcing to third-party asset managers, as institutions seldom possess in-house capabilities to manage these asset classes.
This is all the more true in the insurance segment, which has become the engine for growth in the competitive French institutional market. It has symbolically broken through the €100bn threshold for third-party delegation for the first time this year. The rise of the insurance client translates into new challenges for third-party asset managers. We see a growing overlap between wholesale and institutional distribution as key success factors. Enhanced international co-operation is also required.
In light of these changes, third-party asset managers have to adapt their business development model to capture the new growth opportunities in the institutional market.
Richard Bruyère is managing partner of INDEFI, formerly Image & Finance