Barriers to Entry: Permeating the Insurance Company Investor

INVESTOR SERVICES
PRIME BROKERAGE PERSPECTIVES
Barriers to Entry: Permeating the Insurance
Company Investor Segment
February 2015
Introduction
Constraints on Hedge Fund Investments
Relative to other institutional investor segments, insurance
companies historically have had lower allocations to
alternatives in general and to hedge funds in particular.
Traditionally, insurance company general accounts have been
weighted heavily towards fixed income and credit with lower
allocations to alternative investments. This heavy fixed income
bias stems largely from the stringent risk-based capital (RBC)
frameworks to which insurance companies are subject. Those
regulatory frameworks require insurance companies to hold
large amounts of capital against investments in certain asset
classes, including alternatives and equities.
In order to enhance relationships in the insurance investor
segment, it is necessary to understand the strictures
within which these companies operate concerning hedge
fund allocations. There are several hurdles that insurance
companies face in terms of their ability to allocate capital to
hedge funds, the most obvious of which is the RBC regime to
which such firms are subject.
The low interest rates and depressed bond yields that have
characterized the post-financial crisis period have created a
serious investment income problem for insurance companies,
which face difficulty in meeting their portfolio targets given
their traditional allocation patterns. That difficulty has in
turn created challenges for insurers from an asset-liability
perspective and, in many instances, has resulted in a squeeze
on earnings. Consequently, insurance companies have been
steadily raising their allocations to alternatives in a search for
higher returns. Nonetheless, there remain real barriers that
prevent insurance companies from increasing their hedge
fund exposure beyond a certain level.
In light of the constraints that insurers face with respect
to alternatives, the purpose of this Perspectives piece is to
provide hedge fund managers with additional insights into the
evolving allocation trends of such companies and to highlight
how managers might target and permeate this investor
segment with greater effectiveness. This report is based on
industry data along with interviews with numerous hedge
fund allocators and CIOs at U.S.-based insurance companies.
Risk-Based Capital (RBC) Rules
Although the “low for long” yield environment of recent
years has made alternative investments more attractive to
insurance companies from a return perspective, the RBC
framework renders alternatives very expensive – in some
instances prohibitively so. In the U.S., the RBC rules are under
the jurisdiction of the National Association of Insurance
Commissioners (NAIC), which regulates U.S.-domiciled
insurance companies. These rules stipulate that insurance
companies must hold specified levels of regulatory capital
and are based on several factors, including a prudential
assessment of the risks of the investment holdings in insurers’
portfolios.1 Property and Casualty (P&C) firms are subject to
RBC charges ranging from 10% to 15% for alternatives.
Life insurance companies are subject to an even stricter
RBC regime; capital charges for such firms range from
22.5% to 45%.
1
ccording to the NAIC, RBC is a way of measuring the minimum capital
A
appropriate for an insurance company to support its operations relative
to its size and risk profile. RBC limits the amount of risk a company
can take and requires a company with a higher amount of risk to hold
a higher amount of capital. Capital provides a cushion for a company
against insolvency.
See http://www.naic.org/cipr_topics/topic_risk_based_capital.htm.
This material is provided by J.P. Morgan’s Prime Brokerage business for informational purposes only. It is not a product of J.P. Morgan’s Research
Departments. For institutional and professional investors only. For the intended recipient only.
1
Insurance companies based in Europe will be subject to a
similar and even stricter RBC framework pursuant to Solvency
II, which is scheduled to take effect in January 2016. Under
Solvency II, hedge funds will be subject to a capital charge
of up to 49%. However, for “black box” strategies without
a “look-through” to the underlying assets, an even steeper
capital charge shall apply.
FIG. 1
As a safeguard against outflows, insurers typically hold higher
levels of capital than the regulations require. In fact, in recent
years, RBC levels among U.S. insurance companies have
increased materially, largely as a result of greater regulatory
scrutiny and heightened conservatism among insurers in
reaction to the financial crisis. For example, as Figures 1
and 2 show, RBC ratios among the largest U.S. life insurance
companies have increased noticeably since 2008, although
the upward trend pre-dates the financial crisis.
Historical NAIC Risk-Based Capital ratios
Based on statutory filings for life insurance companies in J.P. Morgan’s Large Company Composite as of year-end 2013
ACL Risk-Based Capital Ratio/2 (%)
900
800
700
RBC Ratios
600
500
400
300
200
100
0
1996Y 1997Y
1998Y 1999Y 2000Y 2001Y 2002Y 2003Y 2004Y 2005Y 2006Y 2007Y 2008Y 2009Y 2010Y

AEG

2011Y 2012Y
2013Y
2011Y
2013Y
 AFL  ALL  AIG  AXA  GNW  HIG  ING  LNC  MFC
MML  NFS  NYL  NML  PAC  PFG  PL  PRU  TIA
Source: J.P. Morgan Insurance Investor Client Management, SNL Financial LC
FIG. 2
Historical NAIC Risk-Based Capital ratios (median)
Median for life insurance companies in J.P. Morgan’s Large Company Composite as of year-end 2013
ACL Risk-Based Capital Ratio/2 (%)
500
Median RBC Ratio
450
400
350
300
250
200
1996Y
1997Y 1998Y 1999Y 2000Y 2001Y 2002Y 2003Y 2004Y 2005Y 2006Y 2007Y 2008Y 2009Y 2010Y
2012Y
Source: J.P. Morgan Insurance Investor Client Management, SNL Financial LC
This material is provided by J.P. Morgan’s Prime Brokerage business for informational purposes only. It is not a product of J.P. Morgan’s Research
Departments. For institutional and professional investors only. For the intended recipient only.
2
From 2006 through 2013, the RBC ratios for the largest life
insurers (depicted in Figures 1 and 2) increased by an average
of +19%, well in excess of the specified requirements. One
might think that, because those companies are now holding
substantially more capital on balance sheet, they would have
more capital for hedge fund allocations, which could help in
their search for yield. However, closer analysis reveals that,
within the current RBC framework, the potential delta of
additional capital for new hedge fund allocations among those
companies totals only $1.2 billion.2 This example underscores
the fact that there is a finite amount of capital available
for hedge fund allocations among insurance companies.
Understanding such limitations is paramount for managers
seeking to grow their relationships in this segment.
FIG. 3
Return Hurdles
The RBC requirements discussed above impose de facto
return hurdles for insurers’ investments in alternatives.
Consequently, insurance company investment committees
face pressure to select investments that justify the attendant
capital charges. That dynamic helps to explain why insurers
traditionally have been larger buyers of private equity than
hedge funds (see Figures 3-4). Historically, private equity is
a higher-returning asset class. Over a three-year horizon,
private equity firms generated an aggregate IRR of 14.5%
versus a 4.0% annualized return for hedge funds; over a
five-year horizon that spread was 17.7% versus 6.5%
(See Figure 5).
Life insurance alternative asset investments3
80
Investment ($billions)
70
60
50
40
30
20
10
0
2008Y
2009Y

Hedge Fund

Private Equity
2010Y

Real Estate
2011Y

Sch BA Fixed Income/Loans
2012Y

Other LPs
2013Y
Total
Source: J.P. Morgan Asset Management Global Insurance Solutions, SNL Financial LC
2
T his figure was derived by calculating the median RBC ratio of J.P. Morgan’s Large Company Composite and the average alternatives allocation of the
same group. For companies with above-median RBC and below-average alternatives allocations, we calculated the amount of additional investment
that would be needed for those firms’ alternatives allocations to equal the average. That number is approximately $12 billion in aggregate. The average
percentage of alternatives that are allocated to hedge funds among those companies was then calculated: 5.38% or $700 million. Companies with little
or no hedge fund exposure were then removed from the average. It was then assumed that the goal among companies in this analysis would be to
match the average hedge fund allocation of insurers with existing hedge fund programs, or 10.76%, which yields $1.2 billion.
3
hereas Figure 1 is drawn from J.P. Morgan’s Large Company Composite, the data sets for figures 3 and 4 are drawn from the broader universe of
W
listed life and P&C insurance companies, respectively.
This material is provided by J.P. Morgan’s Prime Brokerage business for informational purposes only. It is not a product of J.P. Morgan’s Research
Departments. For institutional and professional investors only. For the intended recipient only.
3
FIG. 4
P&C insurance alternative asset investments
35
Investment ($billions)
30
25
20
15
10
5
0
2008Y
2009Y

Hedge Fund

2010Y
Private Equity

2011Y
Real Estate

Sch BA Fixed Income/Loans
2012Y

Other LPs
2013Y
Total
Source: J.P. Morgan Asset Management Global Insurance Solutions, SNL Financial LC
FIG. 5
Hedge fund and private equity returns
Based on HFRI Fund Weighted Composite Index and Cambridge Associates LLC U.S. Private Equity Index
Hedge Fund Annualized Returns
Private Equity Net IRRs
Jun-09
-10.1%
-20.20%
Jun-10
9.1%
19.10%
Jun-11
11.5%
25.40%
Jun-12
-4.3%
6.50%
Jun-13
7.9%
16.80%
Jun-14
9.1%
22.40%
1 Year (6/30)
9.1%
22.40%
3 Year (6/30)
4.0%
14.50%
5 Year (6/30)
6.5%
17.70%
Source: HFR, Cambridge Associates
Volatility
Investment Weightings
Hedge funds can also present a challenge for insurance
company allocators in terms of volatility. Because private
equity investments are illiquid, insurers typically are able
to hold them at cost until realization. By contrast, insurance
companies tend to mark hedge fund assets to market.
Consequently, any material volatility in an insurance
company’s hedge fund holdings can exert a drag on earnings.
Regulatory constraints aside, insurance companies invest to
meet their actuarially modeled future liabilities. Such firms
therefore seek investments that mature close to when their
liabilities are due and which are capable of earning at or in
excess of the discount rate used for premiums. Consequently,
insurance company general accounts tend to be weighted
heavily to investment grade corporate credit and government
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Departments. For institutional and professional investors only. For the intended recipient only.
4
an asset-liability matching perspective to invest in less liquid
asset classes such as hedge funds. Nonetheless, life company
alternatives allocations tend to be lower than that of P&C
companies given the stricter RBC charges to which they are
subject (see Figure 6).
fixed income (see Figures 6 and 7). That pattern has
changed little over time. Because life insurers typically have
longer-dated liabilities than other insurance companies, they
tend to weight their portfolios towards assets with lengthier
durations. Accordingly, life insurers are well positioned from
FIG. 6
P&C and life insurance company investment allocations (2013)
2013 P&C Insurance company allocations




Credit - 18%
Structured Securities - 11%
Treasuries & Agencies - 18%
Munis - 9%




2013 Life Insurance company allocations
Equity - 27%
Mortgage Loans - 1%
Alternatives - 11%
Cash & Other - 5%




Credit - 46%
Structured Securities - 20%
Treasuries & Agencies - 8%
Munis - 1%




Equity - 2%
Mortgage Loans - 13%
Alternatives - 6%
Cash & Other - 4%
Source: J.P. Morgan Insurance Investor Client Management, SNL Financial LC
FIG. 7
Fixed income as a percentage of select insurance company assets
100
90
89.0 90.4 88.7
88.5
83.6
86.6
85.3 85.3
78.9
80
84.7 82.6
82.4
81.1 80.2
73.5
68.9
70
70.0
72.8
74.2
70.3 71.3
69.8 69.6 70.0
64.5 66.3
60.4
60
70.1
65.2 64.4
59.1 58.7
55.1
56.2
49.5
50
47.6
40
30
20
10
0
TRV
HIG
CNA
ZUR
AIG

PRO
2008

2012
CHU

ALL
NFS
LM
SF
USAA
2013
Source: J.P. Morgan Insurance Investor Client Management, SNL Financial LC
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Departments. For institutional and professional investors only. For the intended recipient only.
5
“Low for Long” Headwinds
Given their historic skew towards fixed income, insurance
company portfolios have run into difficulty in recent years as
a result of falling interest rates, which have reached new lows
post-2008. Since the financial crisis, accommodative central
bank policies have driven down the yields on government
debt to historic troughs leading to tighter credit spreads
among other results. The yield on the U.S. 10-Year Treasury,
FIG. 8
for example, has fallen over 180 basis points since 2008
(through year-end 2014). In 2014, a year in which many
market participants anticipated a rise in rates, the yield on
the 10-Year declined by more than 80 basis points. For U.S.
Treasuries, this decline is part of a trend that has been under
way for some time (see Figure 8). This pattern has been fairly
consistent across developed markets. Accordingly, there has
been little opportunity for insurance companies to seek
yield abroad.
Yield on the U.S. 10-Year Treasury (2000-2015)
8.0
7.0
6.0
5.0
4.0
3.0
2.0
1.0
0.0
Jan-00
Jan-01
Jan-02
Jan-03
Jan-04
Jan-05
Jan-06

Jan-07
Jan-08
Jan-09
Jan-10
Jan-11
Jan-12
Jan-13
Jan-14
Jan-15
US 10-Year Treasury Yield
Source: Bloomberg
Income on invested assets is a key driver of earnings for
insurance companies. The declining rate environment has
therefore presented a challenge for insurance company
profitability, especially since insurers tend to hold their
bonds until maturity. Moreover, in many of the asset classes
in which insurers (particularly life companies) invest, credit
spreads are either flat or have compressed. Consequently,
new money yields in many insurance company portfolios have
been declining in recent quarters as higher-yielding bonds roll
off. Over the last year, for instance, new money yields in life
company portfolios were down approximately 40 basis points
and are far below portfolio yields.4 That pattern has
presented another headwind for insurance companies’
investment income.5
Shifting Allocation Patterns
Necessity begets action. Falling yields and tighter credit
spreads have caused many insurance companies to increase
their exposure to other asset classes in search of higher
returns. On the fixed income side, insurance companies have
been taking on more interest rate and credit risk by increasing
their exposure to higher-duration bonds along with allocations
to lower-rated corporate credits, including, in some cases,
high yield.
Insurance companies also have been increasing their
exposure to alternatives—which the NAIC classifies as
“Schedule BA” assets—including hedge funds.6 From 2007
through year-end 2013, life insurers raised their Schedule BA
4
J .P. Morgan North America Equity Research, Life Insurance 2015 Outlook, January 5, 2015, available at https://jpmm.com/research/content/
GPS-1586411-0. J.P. Morgan estimates that the prolonged low interest rate environment will pressure annual life insurance ROEs by approximately
10-20 basis points in the coming years.
5
J.P. Morgan North America Equity Research, Life Insurance 2015 Outlook.
6
T he NAIC classifies non-traditional asset classes, including, but not limited to, alternatives, as “Schedule BA” assets. Schedule BA assets encompass
alternatives such as private equity and hedge funds along with assets such as surplus notes and secured and unsecured loans.
This material is provided by J.P. Morgan’s Prime Brokerage business for informational purposes only. It is not a product of J.P. Morgan’s Research
Departments. For institutional and professional investors only. For the intended recipient only.
6
asset exposure by +23.3% while P&C companies increased
such exposure by +38.8% (see Figure 9).7 Among life insurers,
the most substantial increases in Schedule BA assets have
been through greater exposure to private equity and hedge
funds.8 Such exposure has risen +79.5% in absolute dollar
terms since 2008 (see Figure 10).
FIG. 9
With respect to hedge funds specifically, the carrying value of
such investments—including year-over-year allocations—for
U.S. domiciled life insurers rose from approximately $1.5
billion in 2008 to over $2.6 billion in 2013, or +73%. Among
P&C insurance companies, there was a +71% increase, from
$5.2 billion in 2008 to $8.9 billion in 2013 (see Figure 11). The
upward trend is unmistakable.
Insurance company exposure to Schedule BA assets including alternatives
As a percentage of total invested assets
8
7
6
5
4
3
2
2006
2007
2008
2009

Life Companies
2010

2011
2012
2013
P&C Companies
Source: A.M. Best, Schedule BA Investments – Behind Their Rising Trend, June 30, 2014
FIG. 10
Life insurance company Schedule BA allocations
Allocations reflect underlying investment holdings, not strategy of investment vehicle.
160
140
US $billions
120
100
80
60
40
20
0
2008
2009

Common Stocks
2010

Real Estate
2011

Fixed Income
2012

2013
Miscellaneous
Source: A.M. Best, Schedule BA Investments
S ource: A.M. Best, Schedule BA Investments – Behind Their Rising Trend, June 30, 2014. Part of that uptick was attributable to Berkshire Hathaway’s
purchase of Burlington Northern Santa Fe.
8
Private equity and hedge funds are classified as “Common Stocks” on Schedule BA.
7
This material is provided by J.P. Morgan’s Prime Brokerage business for informational purposes only. It is not a product of J.P. Morgan’s Research
Departments. For institutional and professional investors only. For the intended recipient only.
7
FIG. 11
Carrying value of hedge fund investments among insurers
900
800
$millions
700
600
500
400
300
200
100
0
2008
2009
2010

Life Affilated
2011

2012
2013
P&C Affiliated
Source: J.P. Morgan
Importantly, alternatives exposure for both the life and
P&C industries tends to be concentrated among the larger,
better-capitalized—i.e., highest rated—companies. On average,
88.7% of life insurers rated “a-” or above hold alternatives
exposure, whereas only 37.0% of life companies with ratings
of “bb+” or below do so. Among P&C firms, 55% of the
companies with “a-” ratings or better have investments in
alternatives versus a mere 32.0% of firms with “bb+” ratings
or lower (see Figure 12).9
FIG. 12
BA Asset exposure among Life and P&C Insurance
companies by rating
Rating
Life & Health
Insurers
P&C Insurers
aaa to aa-
94.4%
67.2%
a+ to a-
82.9%
42.8%
bbb+ to bbb-
36.7%
20.7%
bb+ and lower
37.0%
32.0%
Source: A.M. Best, Schedule BA Investments
Considerations for Managers
As the preceding discussion shows, there are significant
tailwinds driving insurance company allocations to hedge
funds. We anticipate that this trend will persist as insurers
continue to increase their exposure to the asset class.
As an example, a major insurer with a large hedge fund
portfolio that was interviewed for this piece anticipates
doubling those investments within the next three to five
years. At the same time, though, the regulatory constraints
that insurance firms face in making such investments are
considerable. Therefore, as hedge fund managers approach
this segment, they must be cognizant of the ways in which
various strategies and structures can impact insurers’
portfolios and balance sheets.
Insurer hedge fund portfolios tend to be highly idiosyncratic
relative to one another. Nonetheless, our conversations with
insurance company investors and our analysis of various
industry data revealed several common patterns across this
segment, which may be additive for hedge fund managers:
Minimal Volatility and Correlation
Among insurance firms, hedge fund allocation patterns vary
considerably from company to company. However, because
insurers mark hedge fund investments to market, as a
segment, they prefer strategies with lower volatility to avoid
potentially negative balance sheet impact.
Generally speaking, therefore, funds with lower volatility
and less correlation are better suited to such investors.
Further, because investment yield is a key driver of earnings,
particularly for life insurers, managers with steadier return
profiles and track records of being able to mitigate acute
drawdowns will find greater receptivity in this segment.
In sum, funds and strategies with the following volatility/
correlation/return profile may be potentially well-suited to
such investors in the insurance segment:
9
A.M. Best, Schedule BA Investments.
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8
Insurance Company
Volatility &
Correlation Matrix
is therefore underpenetrated with respect to alternatives
generally and hedge funds in particular.
Volatility
5% – 8%
Correlation
0.4 or less
Equity Beta
0.4 or less
Sharpe Ratio
1.0 or higher
This is not to say that managers that do not fit these
parameters precisely will be unable to make inroads with
insurance company allocators. But, the more a fund deviates
from the above-listed ranges, the higher the hurdle may be.
Existing Alternatives Exposure
Larger and highly rated insurance companies, both life and
P&C, tend to have well-established alternatives portfolios
and sophisticated teams of varying sizes to manage them.
Among middle market and smaller insurance companies, by
contrast, alternatives portfolios typically are much smaller or
non-existent. That subset of the insurance company segment
FIG. 13
However, hedge fund managers seeking to deepen their
relationships with insurance companies will find more
receptivity among larger companies with existing programs
than they will among middle market and smaller firms.
Companies in the latter group tend to be unfamiliar with
alternative assets and lack the in-house capability to analyze
them. Accordingly, any dialogue with such firms likely would
entail a lengthy, high-touch education process with only
modest prospects for any actual allocations. Companies
with existing alternatives portfolios—even those with only de
minimis hedge fund allocations—generally have the capability
to research and analyze non-traditional assets, are far more
comfortable in the space and far likelier to allocate capital.
Hence, hedge fund managers should target firms with existing
alternatives allocations.
Top insurance companies by Schedule BA holdings10
U.S. Life/Health
company name
Total Ba
Assets
(Usd 000)
U.S. Property/Casualty
Ba/
Invested
Assets (%)
Ba/Total
Capital
(%)
Company Name
Total Ba
Assets
(Usd 000)
Ba/Invested
Assets (%)
Ba/C&S
(%)
Metropolitan Life
& Affiliated Cos
20,957,676
6.7
77.9
Berkshire
Hathaway Ins Gp
54,154,330
25.0
41.6
TIAA Gp
20,168,641
8.9
56.9
New York Life Gp
14,003,009
7.5
66.2
Liberty Mutual
Ins Cos
12,057,784
20.7
68.0
Northwestern
Mutual Gp
11,332,646
6.1
55.1
American Int'l Gp
10,353,049
12.3
37.8
Nationwide Gp
3,885,136
12.3
27.0
AIG Life &
Retirement Gp
11,103,554
5.9
60.4
Travelers Gp
3,524,069
5.5
17.3
Prudential of
America Gp
Allstate Ins Gp
3,522,292
8.7
19.4
8,887,395
4.6
66.4
CNA Ins Cos
2,747,981
6.8
24.7
MassMutual
Fin'l Gp
7,439,514
5.9
50.3
Zurich Fin'l Svcs
NA Gp
2,506,370
10.1
32.0
John Hancock Life
Ins Gp
5,575,739
5.6
77.0
State Farm Gp
2,279,662
1.6
3.0
Principal Fin'l Gp
3,056,770
5.3
64.5
Aegon USA Gp
2,952,173
3.5
32.4
Queen City
Assurance Inc
1,968,523
99.9
107.1
Source: A.M. Best, Schedule BA Investments
10
ot all insurance companies that are Schedule BA filers currently maintain active hedge fund portfolios. Please contact the Capital Introduction Group
N
for more information.
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Departments. For institutional and professional investors only. For the intended recipient only.
9
Multi-Strategy Appetite
Generally speaking, multi-strategy managers are well
positioned with respect to the insurance segment for
two reasons. First, interviews with CIOs and hedge fund
professionals at the larger P&C and life companies indicate
that, while such companies do still invest in funds of hedge
funds (FoFs), their allocations to FoFs are stagnant or
decreasing, as insurers prefer increasingly to invest directly.
Multi-strategy managers have been and are likely to be
beneficiaries of this pattern.
FIG. 14
Second, insurance companies tend to prefer the diversification
that multi-strategy offerings can provide. This preference is
not only a function of portfolio theory but also because, by
holding a wider array of underlying investments including
fixed income and rates, multi-strategy offerings can mitigate
to some degree the RBC impact for insurance companies.
Consequently, the carrying value of insurers’ multi-strategy
hedge fund investments, including year-over-year allocations,
have increased substantially in recent years, growing more
than +58% from 2008 through year-end 2013 (see Figure 14).
Carrying value of hedge fund investments among life insurers by strategy
1.6
1.4
1.2
$billions
1.0
0.8
0.6
0.4
0.2
0.0
2008

2009
2010
2011
2012
2013
Distressed  Emerging Markets  Fixed Income Arbitrage  Global Macro  Equity Long/Short  Multi-Strategy  Equity: Sector-Specific
Source: J.P. Morgan
Parameters
Perhaps unsurprisingly, given insurance companies’ size,
low tolerance for volatility and appetite for steady returns,
they typically prefer larger, more established managers
with built-out track records. More specifically, this means
managers with AUM of $1 billion or more and a three-year
track record. Again, these are not hard and fast parameters
but new launches and emerging managers may find this
segment challenging.
Life Insurers and Longer Locks
Unlike a number of other investor segments, insurance
companies tend to have greater tolerance for illiquidity.
This statement is especially true for life companies given
their longer-dated liabilities. Accordingly, many life insurers
will consider funds with lock-ups – hard or soft – of one to
three years. Although insurance companies tend not to be
particularly fee sensitive, it is not uncommon for them to seek
a fee break in return for longer-term allocations.
With managers across the strategy spectrum coming to
market with longer duration structures as markets become
increasingly illiquid and more volatile, life insurers may be a
potentially fruitful investor sub-set.
Separately Managed Accounts (SMAs)
As discussed, limited partner interests in hedge funds or other
alternative vehicles entail capital charges for insurance firms
because of the RBC frameworks to which they are subject.
Investing in hedge funds via SMAs may help to lessen those
charges. In contrast to limited partner interests in hedge
funds or other alternative investment vehicles, SMAs are not
always deemed to be Schedule BA Assets subject to varying
capital charges. Whether a hedge fund SMA will be subject
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Departments. For institutional and professional investors only. For the intended recipient only.
10
to Schedule BA treatment depends largely on the underlying
strategy and whether that strategy relies heavily on leverage
and/or shorting. Because equities are subject to Schedule
BA treatment, SMAs in equity-based hedge fund strategies
also will be viewed as Schedule BA investments. By contrast,
there may be more benefit for such strategies as macro and
fixed income relative value where the underlying holdings
include rates, futures and bonds, which typically do not entail
punitive capital charges. Once again, though, a fund’s use of
leverage and shorting may blunt such benefits so there are
various nuances about which managers will need to be aware.
But, as a general matter, SMAs may be additive for insurance
companies with respect to non-equity strategies with less
leverage. Managers that are equipped to run SMAs for their
clients may therefore have some advantage with insurance
company allocators.
Conclusion
Despite the myriad constraints that insurance companies face
in making hedge fund investments, there are various tailwinds
driving an overall increase in allocations among this segment.
The current and forecasted rate environment has brought
into question the sustainability of the traditional insurance
company overweight fixed income model. As a result, insurers
are looking to alternatives, and hedge funds specifically, as a
prospective component of the solution.
Understanding the strategies, structures and other attributes
of hedge funds that are palatable for insurers is paramount
for any manager seeking to permeate this segment. We
welcome inquiries from managers interested in discussing
these issues in more detail.
A special thanks to Bill Wallace and Jackie Krasne of J.P. Morgan’s Insurance Investor Client Management (ICM)
team for their help and input on this report. Please feel fee to contact J.P. Morgan’s ICM insurance team (see
below for details).
Contact Us:
Alessandra Tocco
Jonathan Stark
[email protected]
[email protected]
212-272-9132
212-834-2099
Kenny King, CFA
Bill Wallace
[email protected]
[email protected]
212-622-5043
212-834-9339
Christopher M. Evans
Jackie B. Krasne
[email protected]
[email protected]
212-622-5693
212-834-9478
This material is provided by J.P. Morgan’s Prime Brokerage business for informational purposes only. It is not a product of J.P. Morgan’s Research
Departments. For institutional and professional investors only. For the intended recipient only.
11
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