Why are ETFs becoming more attractive to insurers?

With the growing interest in Exchange Traded Funds (ETFs) from European insurers in recent years, Charles Moussier (Head of EMEA Insurance Client Solutions) explores why ETFs are becoming more attractive for insurance investment portfolios.

According to a preconceived notion, insurers rarely use ETFs in their investment strategies and allocations. And indeed, at first glance, there are reasons to think that insurers might not need the benefits traditionally put forward for ETFs. Insurers invest very large tickets and therefore already benefit from very low institutional management fees. They also invest over the very long term and do not necessarily need the increased liquidity offered by the ETF format.

However, this is not the case at all. In recent years, we have observed a rising interest in ETFs from European insurers. This attractiveness will only grow as many of them plan to increase their use of ETFs and index funds. Thus, insurers across major European countries plan to increase the number of ETFs in their portfolios by as much as 46% (in Italy - 42% in UK, 38% in France, 37% in Germany and 45% in the Netherlands and Belgium).¹

Diversification at the heart of insurers' approach

An essential element that differentiates insurers from other investors is their emphasis on diversification. While they may also be sensitive to the intrinsic advantages of ETFs, notably transparency and liquidity, insurers particularly appreciate the variety of the strategies available in ETF format. ETFs enable them to rapidly diversify their allocations by testing new strategies or gaining access to asset classes that are less accessible or less liquid in other formats.

ETF liquidity allows insurers to test their exposures without taking on long-term commitments, and they can also act as an intermediate step for insurers before considering dedicated mandates or funds.

For instance, this is the case with very specific asset classes, such as "Munies" or "municipal bonds", bonds issued by local authorities in the United States (often to finance infrastructure projects: schools, water distribution networks, etc.) and which currently offer a more interesting diversification potential than other bond asset classes without sacrificing yield.

Within our offering, we also note insurers' strong interest in finding yield in high-yield quality debt such as Additional Tier 1 (AT1) bank subordinated debt, Corporate Hybrid debt or Fallen Angels debt (issuers recently downgraded to speculative grade). For these asset classes, the ETFs we provide are often more liquid than the underlying securities.

The rise of factor strategies and ESG ETFs

Additionally, ETFs offer the opportunity for many investors to test strategies based on factors such as momentum, quality or low volatility. According to Invesco's 5th Global Factor Investing Study, released a few weeks ago, the use of factor ETFs has continued to increase among investors in 2020. Most institutional investors now use ETFs, which represent on average 14% of their factor portfolios, and these are replacing factors previously implemented through swaps or other derivative products. 

Finally, ETFs play an important role in institutional investors' integration of environmental, social and governance (ESG) criteria into their portfolios. For insurers especially, ESG ETFs combine strict compliance with regulatory requirements, with flexibility in their asset allocation and the fine-tuning of their ESG strategy, which may even include self-indexing mechanisms.

Increased focus on liquidity

To select their ETFs, insurers look at three main criteria: the liquidity of the fund (in relation to the volume of transactions), the cost of the product, and the performance of the fund (including its tracking error).

Liquidity is one of the most important criteria for insurers. Keeping in mind their units of accounts, horizon funds or retirement plans, insurers must manage liquidity as well as possible to cope with more frequent and larger withdrawals from their customers.

All these reasons suggest that ETFs have a bright future in the investment portfolios of European insurers.