Insurers glum about investment outlook as low yields bite

Low or negative yields and surging equity markets are making insurers gloomy about the outlook for their investments, according to a Goldman Sachs Asset Management survey of nearly 300 senior insurance executives across the globe.
The insurers, who collectively invest more than $6 trillion, were the most pessimistic since the annual survey began four years ago, GSAM said on Wednesday.
Bond yields have turned negative in several European countries this year, following the introduction of quantitative easing by the European Central Bank, while low interest rates around the world have helped swell stock prices.
This has led insurers to move further into alternative asset classes in the hunt for rising returns to match their liabilities.
“Insurers … are looking to increase allocations to less liquid, private asset classes,” Michael Siegel, GSAM’s global head of insurance asset management, said in a statement.
The executives see private equity markets as likely to offer the best returns in the next 12 months, while cash and large corporate loans are least favored.
Insurers based in Europe, the Middle East and Africa were particularly downbeat, with 74 percent believing investment opportunities are getting worse.
The International Monetary Fund last week highlighted issues in Europe’s life insurance sector, where companies may have difficulty making guaranteed payments to their policyholders when interest rates are low.
PE Hub

Corporate Pension Funds Pile Into Bonds

Increased appetite fuels demand for highly rated debt issues

Corporate pension plans have become a force to be reckoned with in the bond markets.
For the first time in more than a decade, large pension funds hold more bonds than stocks. Their increased appetite is fueling demand for highly rated debt issues, pushing up prices and driving down yields. That, in turn, could make it cheaper for companies to borrow money for years to come.
The trend is being driven by finance executives who have grown increasingly conscious of the risk underfunded pension plans pose to earnings. Last year ballooning pension obligations hurt the fourth-quarter profits of several large companies, including AT&T Inc, General Motors Co, and Kellogg Co.
“It’s just crippling to companies,” said John Jeffrey, a consultant at benefits adviser Conrad Siegel Actuaries. “They don’t know what’s coming.”
Companies with defined-benefit pension plans—those that guarantee a set payout—have been struggling to fund their obligations to retirees since 2008, when the recession sent asset values tumbling and liabilities soaring.
By increasing their holdings of long-term bonds, companies can more closely match their returns to their future commitments. Such asset-and-liability matching allows companies to limit the volatility of their pension obligations and lock in gains.
The strategy also can reduce the hit a company’s earnings might take if the value of its pension plan’s stockholdings fall, and can make a pension plan more attractive to outsiders, reducing the premium a company might have to pay to shift its pension burden to a third party.
GM, Verizon Communications Inc, and Bristol-Myers Squibb Co. , among others, have transferred more than $40 billion in pension obligations to insurers in the past three years.
The 50 largest defined benefit plans in the S&P 500 held 41% of their $941.7 billion in total assets in bonds last year and 37% in stocks, according to Goldman Sachs Asset Management. That’s the first time bonds have outweighed stocks since at least 2002, when the firm started tracking the data.
 

International Business Machines Corp., Exxon Mobil Corp. , and GM are among the companies that have been vacuuming up investment-grade corporate debt. But, because pension funds tend to be buy-and-hold investors, their mass move into bonds is making it increasingly hard to find the long-term, high-quality debt issues the plans need.
Last year, Meritor Inc. boosted the fixed-income holdings in its U.S. pension plan to 41% of the plan’s total assets from 36% the year before—an $88 million increase.
These days, however, it can take the company’s pension-plan managers more than a month to find the kind of bonds they want, and they may have to pay a premium for them. “It’s getting a little bit more challenging,” said Carl Anderson, the auto- and truck-parts maker’s treasurer.
The shift to bonds could accelerate in the coming years as the Federal Reserve debates whether to raise benchmark interest rates, said Rafael Silveira, a portfolio strategist at J.P. Morgan Asset Management. Such a move would increase rates offered on new bonds, making them more attractive to pension plans and other investors.
Yields on high-rated U.S. corporate bonds maturing in 10 years or more have been below 5% since March of last year. During the recession, yields topped 9%, according to Barclays PLC.
To be sure, some pension funds are still looking to invest more in the stock market in the short term to help their funding status. Underfunding generally increased last year as lower interest rates raised the current value of future payments promised to retirees.
A broader set of pension data based on the Russell 3000 Index, which tracks the 3,000 largest U.S. companies, shows that equities still outweigh bonds, according to J.P. Morgan Asset Management, by 50% to 39%.
Still, the moves by the bigger pension plans are significant. “Normally, the larger plans are the leaders in some trends,” said Mr. Silveira.
Stocks have the potential to return more than bonds, so having more stocks could juice asset values. But stocks are also riskier, and many companies would prefer to avoid the risks.
As more funds adopt the matching strategy, pension demand for long-term, investment-grade debt could total about $150 billion a year, said Michael Moran, pension strategist at Goldman Sachs Asset Management. That would be a sizable chunk of the market.
Last year, companies sold a record $604.9 billion of investment-grade bonds with maturities of 10 years or longer, according to Dealogic. That’s almost double the annual average of $318.3 billion since 1995.
Justin D’Ercole, head of U.S. investment-grade syndicate at Barclays, estimated that pension funds account for more than half of the buyers for new 40-year and 50-year corporate bonds. A few years ago, he would have pegged their share at around 25%.
Companies are seizing on that demand to raise capital. Last week, demand for 50-year bonds issued by Massachusetts Mutual Life Insurance Co. was so strong that the company raked in $500 million, much more than its originally planned $350 million. In February, Microsoft Corp. sold $2.25 billion of bonds maturing in 40 years.
The fact that retirees are living longer is something companies must face. New accounting standards on life expectancy issued late last year are forcing more finance executives to increase the size of their pension obligations. That’s compelling many to consider how they want to carry that burden on their balance sheets.
GM began actively matching its pension assets with its obligations about five years ago, after emerging from bankruptcy proceedings, said Dhivya Suryadevara, chief executive and chief investment officer of the auto maker’s asset-management division.
The market crash of 2008 reminded corporate executives of the risks that falling interest rates and stock prices posed to their balance sheets, said Ms. Suryadevara. She said that moving into bonds earlier than most helped GM get ahead of the competition.
GM’s U.S. pension plan, which is 86% funded, holds roughly 60% of its assets in bonds, up from about 42% in 2009.
Because of its size, the company has to be careful when buying bonds. “You don’t want to tilt the market,” she said.
Collectively, however, corporate pensions are doing just that.

Vipal Monga and Mike Cherney - Wall Street Journal

A nuanced play

LPs interest in private debt is increasing....
Aivars Lode
  
Pension fund interest in private debt is increasing. But just how are these institutional investors allocating?


Pension funds are making growing commitments to private debt strategies, PDI hears. In the UK, one of Europe’s most active private debt markets, pension fund managers are attracted to the risk-adjusted returns of the asset class, we’re told It’s well-known that their brethren in the US are already allocating, but pension fund managers in the UK have been, shall we say, a little coyer. So PDI went to the National Association of Pension Funds’ annual investment conference in Edinburgh last week in search of clues that this might be changing.

With decreasing yields and increasing outgoings as pensioners live longer, how are pension fund managers going to meet future liabilities and are they considering private debt? Truth be told, they are considering many options, including invigorating their investment strategies.

Private debt is just one strategy to pique their interest, with key words like ‘infrastructure’ and ‘real assets’ frequently brought up during discussions too. ‘The Chinese are looking at UK infrastructure – why don’t we!’ to paraphrase one scheme manager in Edinburgh.

Amongst those to put their heads above the parapet in regards to private debt is local authority pension scheme the London Pensions Fund Authority (LPFA). It created a framework for procurement recently to secure the services of an alternative credit manager, a route not typically traversed by public pension funds when allocating to private debt.

Four managers - Apollo Global Management, Ares Management, Babson Capital and GSO Capital Partners - have been shortlisted to co-manage the LPFA’s £100 million to £150 million mandate.

Making the grade is quite a coup for these four manages given that within the new framework all 99 of Britain’s local authority pension fund plans affiliated via the Local Government Pension Scheme and overseeing roughly £180 billion (€249.2 billion; $267.4 billion) can appoint any of them to manage segregated accounts during the next three years. Whether they will or not remains to be seen, but the LPFA is expected to pick at least one by the end of March.

The chosen four have made it as a result of the multiple vertical strategies they offer, LPFA chief investment officer, Chris Rule said. And an impetus for investment from LPFA’s perspective is to learn more about the private credit asset class, he added.
This is food for thought, as it appears to confirm that pension fund managers are getting more hands on with their funds. The UK industry-backed Pensions Infrastructure Platform (PIP), which will invest £1 billion in UK infrastructure assets including debt, is another good example of this.

Many pension fund managers are familiar with private debt in the original sense - mezzanine and distressed strategies. But direct lending, particularly to corporates not backed by private equity sponsors, is a new idea. Direct lending falls somewhere in the middle of the private debt returns scale, between infrastructure on the lower end and more opportunistic investments at the higher, Gregg Disdale, senior investment consultant at pension advisor Towers Watson, explained to PDI.

How pension funds allocate depends on their specific circumstances. Some corporate pension schemes running large deficits are allocating to private debt, as they seek better returns on a risk-adjusted basis, PDI understands. The opportunity to gain exposure to lending in a region where banks are restricted is very compelling, as are the returns.
But far from reducing exposure to the low yielding public markets completely, at most a UK pension fund manager might make a new allocation of around 5 percent to the asset class, coming from both their credit and private equity allocations.

As always, illiquidity is an important factor for pension fund managers to get to grips with. It’s all about relative value. As Disdale puts it: “The critical question for us when assessing these ideas is are we being sufficiently compensated for locking up our capital. You need to believe you are being better paid per unit of risk versus other alternative credit investments.”
Surfacing data that will help UK pension fund trustees answer this question will ultimately decide how meaningful a role private debt will come to play in their portfolios.

- Private Debt Investor 

Is GP Restructuring An Emerging Asset Class?

As PE funds expire there is a restructuring of the industry coming....
Aivars Lode

A decade ago saw one of the boom periods for private equity with $1T of funds raised between 2005 and 2008. Now that most funds raised during that time are approaching the end of their 10-year contractual life, there has been a surge in GP-led fund restructuring transactions that has many in the industry looking at the space as an emerging and attractive asset class for investment.

“The restructuring of a PE fund is driven by LPs seeking liquidity in these older vintage funds and the tension with GPs who require more time or more capital to realize future value in its portfolio companies”,” says ICG Director of Secondaries Christophe Browne, speaking to Privcap at Hycroft’s 2015 Private Equity Conference in Miami.
“The structure of private equity funds doesn’t always mirror the right time to sell assets and realize maximum value,” he says.
The financial crisis pushed out the holding period for almost all PE-owned companies, and now a growing number of assets are now managed by GPs who ended up “underwater” on the economic incentives, which has caused some misalignment of interests between GPs and LPs.
For Browne, this type of crisis presents an opportunity for his team of specialist secondary portfolio buyout experts.
“When you look at the 2005 to 2008 vintage of funds that are now reaching expiration but have not performed, the management fee becomes the only incentive for the GP and LPs don’t have liquidity options,” he says. “That’s the perfect opportunity for us to go in and offer LPs a comprehensive solution by partnering with the incumbent GP to buyout all of its remaining unsold assets with a rollover option into the newly restructured vehicle”.
But the process of restructuring a PE fund is complex and requires a unique set of multi-asset due diligence capabilities and multi-party negotiating skills in order to complete a transaction in a relatively short amount of time.
Last year, Browne, along with ICG’s Global Head of Secondaries Andrew Hawkins, executed a successful restructuring of the 2005 vintage Diamond Castle Partners IV fund with a new $860M investment vehicle acquiring the portfolio of eight remaining companies and managed by Diamond Castle’s GP team.
“Diamond Castle was a classic example of a restructuring transaction, which had the challenges of a complex process and multi-party negotiation,” says Browne. “The fund was nine years old and there had been changes in the leadership partner group at the GP. Yet, there was still over $700M of net asset value remaining in eight portfolio companies.”
Browne adds that ICG’s job was to negotiate a satisfactory deal that would be accepted by more than 75 LPs, along with a partnership agreement with the GP to align interests for a new holding period. At the same time, they had to perform asset-level due diligence on eight companies in a matter of 45 days and be out with a tender offer to LPs in 60 days, he says. “It’s always a herculean task to get the deal done, but it’s great when it all comes together with a good outcome for all parties.”

By Mike Straka, Privcap

Specialization

Specialization: As the private equity environment gets more competitive, some firms are finding an advantage by specializing in specific sectors. And according to a new study from Cambridge Associates, their limited partners are benefitting from their specialization.

Sector-focused funds have returned an aggregate 2.2x multiple on invested capital and a 23.2 percent gross internal rate of return between 2001 and 2010, Cambridge said. That compares to the 1.9x multiple and 17.5 percent gross IRR returned by generalist funds during that time period.

Cambridge defines sector-focused funds as those that invest more than 70 percent of their capital in the consumer, financial services, healthcare or technology sectors.

“In an increasingly competitive private equity environment, a manager’s ability to demonstrate deep expertise in a focused field is a key differentiator,” Andrea Auerbach, global head of private investment research at Cambridge, said in a statement.

The challenge for LPs is to determine who is really a sector expert, Auerbach said in an interview.

Many firms claim to focus on several sectors, but it’s important to determine if they “live and breathe” the sector, or if they are simply calling themselves specialists “so the right sector banker can find you with their deal flow,” Auerbach said.

“You can have sector-focused individuals, or teams within larger firms who are ultimately competing against complete firms [where] that’s all they do is that sector,” Auerbach said.

PEHUB

SEC probing private equity performance figures: Reuters

The U.S. Securities and Exchange Commission is examining how private equity firms report a key metric of their past performance when they market new funds to investors, as the regulator boosts its scrutiny of the industry, according to people familiar with the matter. At issue is how private equity firms report how they calculate average net returns in past funds in their marketing materials, the sources said. Net returns, also known as the net internal rate of return (IRR) and an indicator of investors’ actual profits, deduct private equity fund investors’ fees and expenses from a fund’s gross profits. Private equity fees are not standard and different investors in the same fund can pay different fees. Fund investors such as pension funds, insurance companies and wealthy individuals – known as limited partners – pay the fees to the private equity firm. The private equity firm and its managers, called general partners, also typically invest some of their own money into the funds, but don’t pay any fees. Including the general partner’s money in the average net returns can inflate the fund’s average net performance figure, and the SEC is investigating whether private equity fund managers properly disclose whether they are doing that or not, the sources said. An SEC spokeswoman declined to comment. The SEC’s focus on the average net IRR disclosures, which has not been previously reported, marks a new phase in the agency’s efforts to regulate private equity and comes at a time when the industry is already under pressure from investors to simplify its fees and expenses structure. The emphasis on performance figures is likely to cause many buyout firms to review their regulatory compliance measures and force them to increase disclosures and make their numbers more intelligible to investors.There is no standard practice for calculating average net IRRs among the roughly 3,300 private equity firms headquartered in the United States. A Reuters review of regulatory filings and interviews with people familiar with different firms’ practices show the calculation varies widely even among the top private equity firms. Blackstone Group LP, Carlyle Group LP and Bain Capital LLC, for example, do not include money that comes from general partners in average net IRR calculations, while Apollo Global Management LLC does, the review shows. Fund marketing documents are not public, but the sources said all these firms disclose to investors whether they include general partner capital in the calculation or not. The SEC’s review comes after the agency put together a dedicated group earlier this year to examine private equity and hedge funds that had to register with it as part of the 2010 Dodd-Frank financial reform law, Reuters first reported in April. Much of the SEC’s focus so far had been on fees that private equity funds charge. In a May 6 speech, Andrew J. Bowden, director of the SEC’s Office of Compliance Inspections and Examinations, said more than half of the private equity funds the agency examined had inappropriately allocated expenses and collected fees. COMPLEX CALCULATION The average net IRR figure is crucial to investors’ understanding of their actual profits from private equity funds. To continue reading this story, please visit peHUB.com. By Greg Roumeliotis

Changes in Investment Needs to think about