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France: The search for yield

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Richard Bruyère presents the results of Image & Finance’s 12th annual research covering the institutional market

Institutional investors in France are feeling better. While 2011 was a nightmarish reminder of the darkest hours of 2008, last year provided a well-deserved breather as all asset classes registered positive investment performance. Despite these strong results, the French institutional market is not yet out of the woods. First of all, growth remains a challenge as demographics and the economic crisis take their toll on the welfare state institutions. Second, as in the rest of Europe, French institutional investors have to solve the asset allocation conundrum in an era of financial repression.

These two challenges are analysed in detail in 2013 research by Image & Finance (I&F) covering institutional investment in France. It relies on contributions from investors which manage close to €2trn of assets for their own account (in market value). Our 2013 panel includes:
• 99 insurance companies;
• 39 pension institutions;
• 55 other long-term investors (including bank proprietary investment books, industrial liability funds, guarantee funds, foundations and associations).

Growth: a short-term challenge
Institutional assets have increased by €90bn year-on-year (an additional 5%). According to our data, the French institutional market has registered net outflows in 2012 for the first time in history.

There are several reasons for this sorry state of affairs.

Since 2010, individual life insurance (slightly over 50% of total assets) did not play its role as the main engine for growth in the French institutional market. In 2012, according to the industry body FFSA, net outflows reached €3.6bn. This is due to a combination of factors:
• Bancassurance networks (which hold two-thirds of the market for individual life policy distribution) have moved away from off-balance sheet investment products to focus on raising liquidity for their group (in the wake of the new Basel III funding constraints);
• The relative attractiveness of life insurance policies has been eroded by decreasing yields and competition from regulated saving accounts;
• Demographic imbalance and the economic crisis has led to increased withdrawals of savings under insurance policies.

Yet the reality is somewhat more nuanced than headline figures would suggest. Insurance outflows actually affected a limited number of players. In our database of almost 100 insurance companies, most keep growing their assets (non-life, health, pension-focused insurance businesses). Only the 10 or so largest, historic bancassurance leaders have suffered outflows. Pressure should now be lowered as Basel III funding constraints are relaxed and banking networks focus on restoring their profitability, as illustrated by reported inflow figures this year

A second outflow is the structural imbalances of the general pension regime (Agirc-Arrco). €5bn vanished from the long-term reserves of the pension institutions in 2012. We analysed these changes in our article last year and will therefore not dwell on them.

However, it is worth mentioning that adjustment measures are currently being implemented to correct these imbalances:
• Moving to a monthly payment schedule of pensions (instead of quarterly) will contribute to improving the regime’s working capital position, starting early 2014.
More fundamentally, social partners came to a recent agreement (mid-March), whereby:
• Pensions will be decoupled from inflation for three years starting from 1 April 2013, resulting in approximately €2bn in savings;
• In addition, employer (60%) and employee (40%) contributions will be raised in 2014 and 2015 by 0.1% in order to generate more than €1bn in additional resources.

It is difficult to predict whether these technical measures will be enough to withstand the demographic shock and economic crisis.

The pension system in France is due for an overhaul next year as the government is preparing an in-depth reform.

Asset allocations: the quest for yield
Unlike pension fund-dominated countries, the French institutional market remains heavily influenced by insurance companies (which represent up to 80% of the asset base). One of the main specifics of insurance investing is the requirement to generate annual yield. Hence the relative weight of fixed income in French institutional asset allocations (up to 75% of long-term investments).

With the current level of interest rates and the regulatory constraints imposed on insurance companies in terms of investments (Solvency II), fixed income diversification is the name of the game in the French institutional market.

Already, the 2011 euro-zone crisis led to a change in the balance of fixed income portfolios, amounts allocated to credit having overtaken government bonds by year-end. Diversification is being pursued further with increasing allocations to high yield (euro and US) and emerging debt.

But the grande affaire of the institutional market over the past 18 months, as in some
other European countries, has been investment in private debt, be they corporate or local authorities private placements and loans, real estate or infrastructure debt. This move is being led by leading insurance companies, closely mirrored in their diversification strategy by pension institutions with sufficiently stable investment outlooks.

Several factors underpin the reason for these institutions’ diversification:
• The European bank deleveraging process provides a unique opportunity for institutional investors to step into the funding cycle of the economy, on relatively attractive terms;
• Private debt investments offer an appreciable liquidity premium that insurance companies can afford to capture, due to the long-term and stable nature of their liabilities;
• The loan market provides for credit issuer diversification at a time where most large insurers have reached their maximum allocation to euro high yield;
• Political concerns are no stranger to this trend, as insurance companies need to strengthen their position vis-à-vis public authorities. Being portrayed as funding providers to the real economy is one way for them to enhance their public image.

Obviously, this move is not unilateral and obstacles (not least regulatory uncertainties) need to be overcome. Yet, we estimate that, at the scale of the French market, there could be up to 2% of fixed income portfolios diverted from traditional asset classes (mostly sovereign bonds) towards private debt investments by the end of 2015.

Asset managers need to re-engineer their offering and market approach
This is a significant opportunity for third-party asset managers. Few institutions have
the required in-house skills and resources to implement this change in allocations themselves. In this area, institutions are looking for specialist asset managers with a long track record. Private equity general partners also have a natural legitimacy in the eyes of institutional investors.

 Similar structural evolution can be seen for other asset classes, such as flexible balanced products or low-volatility equities, thereby changing the competitive dynamics of the French institutional market.

In light of these trends, it becomes ever more critical for third-party asset managers to recognise their core capabilities, adapt their business development strategy and focus their resources accordingly.

Richard Bruyère is president of Image & Finance, an INDEFI Group company

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