Adding upside potential to insurance portfolios

We look at how an ‘Equity Enhanced Fixed Income' approach could offer insurers an attractive return profile, while providing equity risk management capabilities. And importantly, it can be delivered in a capital efficient way.

Since the global financial crisis, persistently strong equity markets and muted volatility have led to a prolonged period of market complacency. Recent movements in equity volatility, combined with the prospect of rising interest rates may prompt investors to search for investment strategies that can help capture potential equity upside while also mitigating risk. Meanwhile, interest rates and credit spreads have remained low by historical standards, making it increasingly difficult to find attractive risk-adjusted returns in traditional fixed income markets. Many insurers have been moving further out the risk spectrum, allocating more to equity and alternatives – yet this naturally increases concern about downside risk.

Previously, insurers have used convertible bonds in their portfolios. The public convertible securities market has contracted meaningfully in size over the
past decade (particularly the investment grade segment), often trades rich to theoretical value, and as a result, offers less opportunity to identify attractive
investments. Traditional convertibles are also rigid in design and provide limited flexibility to adequately reflect a manager’s investment views.

Equity Enhanced Fixed Income

We believe a unique way to manage this challenge is by pairing fixed income securities with equity options that seek to attain the stability of fixed income securities with equity upside. This approach – what we call Equity Enhanced Fixed Income (EEFI) – can offer insurers an attractive return profile, while providing equity risk management capabilities. And importantly, it can be done in a capital efficient way.

An EEFI strategy can be a complement or an alternative to traditional convertibles, providing the same attractive profile but through larger, more liquid investment universes with opportunities for greater portfolio customization. 

A critical advantage of EEFI is that the fixed income and equity components can be tailored independently to reflect compelling investment views, and the embedded equity exposure can be customized to introduce various degrees of equity sensitivity to a portfolio. 

In this paper, we provide a brief refresher on the fundamental characteristics of convertible securities and then explore three compelling reasons why we believe an EEFI strategy can and should be part of a well-balanced portfolio.

Download the whitepaper 

Investment risks

The value of investments and any income will fluctuate (this may partly be the result of exchange rate fluctuations) and investors may not get back the full amount invested.

Important information

Where individuals or the business have expressed opinions, they are based on current market conditions, they may differ from those of other investment professionals and are subject to change without notice.