I recently had the opportunity to speak with Raghu Ramachandran, head of the Insurance Asset Channel at S&P Dow Jones Indices. An expert on the use of ETFs by insurance companies, Ramachandran draws on his extensive experience in portfolio and liquidity management, portfolio strategy, hedging, product development, and stochastic modelling. Each year, S&P Dow Jones Indices publishes a widely respected analysis of ETF usage by insurance companies. We highlighted several insights from the 2020 report in an earlier blog.
Below are excerpts from our conversation, featuring a discussion about the varying ways ETFs are being utilized in general account portfolios and how senior leaders at insurance companies are becoming more knowledgeable about the ETF market.
You’ve been analyzing the use of ETFs by insurance companies for more than a decade. Over this time span, what changes have you observed in the way insurance CIOs approach ETFs?
Insurance CIOs are quickly coming up the learning curve, especially when it comes to sharpening their knowledge about the capital markets functions of ETFs. For example, CIOs today are savvier about the trading mechanisms of ETFs and how they differ from traditional OTC bond markets. CIOs are rapidly building a strong understanding of how to access the market and execute effective, cost-efficient trading strategies.
In addition, insurance CIOs are increasingly discovering that the ETF market is generally deep enough to handle large transactions without being disrupted. When we examine publicly available records of insurers’ securities holdings, we see a consistent pattern: Approximately 50% of ETF trades by insurance companies are a full “round trip” within a single year, meaning the ETFs are entering and exiting the portfolios within the same year. This is solid evidence that insurance CIOs are growing to appreciate ETFs as a flexible, liquid tool for portfolio management.
Lastly, CIOs are working to build appropriate frameworks for ETF analysis, especially for fixed income ETFs. In contrast to an individual bond, where metrics like duration and yield are often the focus, analysis of a fixed income ETF requires a thorough understanding of the underlying index and how the ETF is constructed, including its allowable securities, exclusions, and specifics such as credit rating criteria.
How would you describe the evolution of ETF applications in insurance general account portfolios?
Many insurers start out using ETFs in simple cases. As they grow more comfortable with the ETF ecosystem, we see usage increase and become more complex and innovative. For example, an insurer may begin using ETFs to manage inflows. Instead of trying to source individual bonds to accommodate a $10 million inflow all in one day — which can be an impossible task — the portfolio manager will use an ETF to put the cash to work right away at a specific duration and yield. As the individual securities are sourced over time, the portfolio manager can sell out of the ETF in incremental pieces to fund the purchases. A more intermediate application would be using ETFs as a funding vehicle for private credit and private equity investments.
On the sophisticated end of the spectrum, we see insurers using ETFs to create ballast for their risk budgets. For example, a portfolio manager could choose to assign 20% of their equity allocation to an active manager and put the remaining 80% in an ETF. In this scenario, the ETF contributes 0% to the equity risk budget, which means the active manager can be given 100% of the risk budget, enabling the active manager to add value without confronting constraints.
We’re seeing this evolution unfold with large- and mega-sized insurers. Initially, their usage of ETFs was relatively limited; as big firms, they had access to a full range of investment products at very competitive prices. Since 2015, though, mega-sized insurers have steadily increased their allocation to ETFs as they identify and implement new use cases. Between 2015 and 2020, their ETF AUM increased by 30% each year.1
What data will you be watching closely in the coming months?
In 2020, we saw a spike in ETF trading volume, largely driven by the COVID-19 crisis. Volume has come down a bit in 2021, but I’ll be watching where it lands at year end. I’ll also be watching for data around ESG themes. The overall investment community remains quite focused on ESG, and in the insurance industry, some anecdotal evidence suggests that interest is growing. I’ll be watching to see if insurers’ interest in ESG is happening in any noteworthy size — or if we are in a “testing the waters” phase.
I’d like to extend special thanks to Raghu Ramachandran for sharing his views and look forward to exploring many of the topics covered here in future blogs.
To learn more about how we may be able to assist you and your clients, please reach out to the SPDR Insurance Team, Benjamin Woloshin and Dewey Yoo. You can also see the full SPDR ETF line-up here, along with NAIC designations and S&P ratings where applicable.
The views expressed in this material are the views of Raghu Ramachandran and the SPDR Insurance Team through the period ended December 31, 2021 and are subject to change based on market and other conditions. This document contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.
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