Small Insurer Boosts Sophistication, Adds Alternatives

Foresters Friendly has been drawing the attention of the insurance investment industry in 2019, with accolades for its new approach featuring a high-quality multi-asset solution complemented by new forays into private markets.

Corrado Pistarino
Chief Investment Officer, Foresters Friendly

The group’s lean investment team, advised by Chief Investment Officer Corrado Pistarino (pictured), recently picked up the “Best Small Insurer” gong at the 2019 Insurance Investment Exchange Awards. The key: striking a balance between “efficiency” and “excellence,” with the need for low costs and governance simplicity on the one hand but a desire for optimal investment outcomes on the other.

Pistarino sat down with bfinance Investor Spotlight to discuss the recent changes and what’s in store next, including further exploration of private market strategies, the gradual unwinding of a legacy real estate portfolio and deeper consideration of climate change investing. The pursuit of better investment outcomes remains his core focus: “Foresters are entrusted with the stewardship of our members’ savings,” he says; “their future welfare may hinge on the day-to-day investment decisions.”

Q: Could you give us a brief introduction to Foresters, and your role in the firm?

When I joined the Railpen equity team in 2011 my role mainly involved overseeing asset managers – all of the assets were managed externally at that time. What followed was a programme of transformation, which kicked off in 2014 after some initial analysis in 2013. We restructured, implementing investments through a simplified set of pooled funds that we managed. We made some big changes to investment strategy, such as increasing factor investing in equities. And we began to internalise the management of assets, gradually bringing our public market investments in-house. We’ve moved from 100% external management of assets in 2014 to less than 50% today. Throughout, there has been a strong focus on cost. The total expense ratio of the scheme has halved.

Q: Could you give us a brief introduction to Foresters, and your role in the firm?

To some extent, Foresters face the same challenges that all small institutional investors, or small-to-mid-sized insurers, tend to face: cost efficiency, regulatory burdens, resource constraints. Foresters is a mutual life insurer offering a wide range of savings and life cover products backed by with-profit and unit-linked funds; the investment portfolios amount to around £250 million.

When I joined, about two years ago, the Society was invested in conventional asset classes (UK equities, UK credit, UK Gilts) alongside a legacy property portfolio. Until then, the investment function was the direct responsibility of the CFO - there was no CIO figure advising her. The Board concluded that this set-up was unsatisfactory and had to change in order to boost investment performance, improve monitoring of risk and provide better value for money for members. After I joined as CIO the investment team was further strengthened with the hiring of an experienced Investment manager.

Q: Having joined, what did you see as the key issues which you wanted to address?

It became immediately evident that there were a couple of problems that required immediate attention. Firstly, the incumbent multi-asset manager (who handled all investments apart from the property portfolio) did not have a strong presence in the insurance money management space, and we felt at times that the line of communication affecting the investment decision process was not as smooth as they would hope. Managing insurance money is complex: investment choices that are reasonable in an unconstrained framework turn out to be sub-optimal when solvency capital consumption, liquidity and other balance sheet constraints are factored in. The asset management industry has moved significantly over the past decade in developing dedicated portfolio management and multi-disciplinary coverage teams for insurance clients in order to bridge that communication gap, and I wanted to take full advantage of that shift in the quality of service.

The second concern was about the lack of diversification in the portfolios, both geographically and in terms of asset classes. I would question the wisdom of building an investment portfolio strongly biased toward the domestic economy, when the company’s business risk is entirely domestic, as it is the case for Foresters. When it comes to asset class diversification, over the last decade we have been witnessing a significant move towards alternative investments which offer what appears to be a superior expected risk/return profile, often at the cost of increased opacity. The portfolios, with the exclusion of the property holdings, were only exposed to liquid strategies and I felt that some interesting investment opportunities were being missed.

Q: How did you go about changing managers?

Foresters re-brokered that multi-asset manager mandate. The intention was to explore the broader possible range of investment managers, evaluate their offering under a set of customised metrics designed to highlight the managers’ skill set and suitability, and identify the service provider that would prove to be the best fit for our needs. I saw this process as a key step in the wider effort of promoting Foresters as an innovative institution, creating value for members despite the obvious limitations of being a small insurer.

During this search, I also gave a lot of thoughts to the subject of alternative investments. Foresters wanted to select an investment house with strong and demonstrable capabilities in this space in order to streamline the portfolio mandate. But it was also important to retain the option to choose separate “best in class” managers for illiquid strategies.

In the end, Foresters selected AXA Investment Managers. They scored very highly across a range of high-priority criteria. A mandate was designed as a mix of directly held assets (UK Gilts, Global Credit) and pooled funds. The mandate includes an allocation to alternatives at a discounted fee. Yet, in alternatives, the Society has the discretion to decide on any potential investment beforehand. Exposure is only permitted after a satisfactory due diligence process has taken place. The same process applies when investing with specialist alternatives managers outside the AXA IM mandate.

Q: What were the key criteria for your selection?

The selected manager had strong expertise in investing for the insurance sector, as you would expect from the affiliate of the largest global insurance company. That expertise was a key requirement during the RFP process: asset managers that could not prove these credentials were dropped early in the search. They were also efficient from a cost perspective.

Foresters also looked at their track record for active management. I expect the portfolio manager to be adding value through active decisions, including dynamic asset allocation and security selection. I worked with AXA IM to devise a strategic asset allocation, based on a notion of capital consumption at a portfolio level, but with exposure bands for each asset class within which the portfolio managers can exercise their judgement and deviate tactically from the central weighting – I have a strong conviction that they should be able to add value through dynamic asset allocation. I am also hoping that value will be added through security selection, whether that is carried out by the portfolio manager (in the case of directly held assets) or by the portfolio managers of the pooled funds Foresters invest in.

The quality of the economic thinking demonstrated by AXA IM, and indeed by all asset managers in what was a very strong shortlist, matched up to another key requirement: the ability to elucidate macro scenarios and translate their thinking, clearly and consistently, into tactical market views. It is critical for us to understand how AXA IM sees the economic landscape evolving, its impact on asset prices and the resulting decisions on asset allocation. A constant line of communication, not limited to the quarterly investment committee or the occurrence of major market events, enables Foresters to discuss and challenge their investment views and monitor the risk profile of our portfolios. Engagement occurs at many levels, from investment ideas to optimal capital management. I see real value being generated by this continuous interaction.

Q: You spoke about alternative investments. How are you developing in this space?

Foresters are interested in a broad range of alternatives including private debt, infrastructure (equity and debt) and private equity. Having built some exposure to European SME loans through a specialist alternative manager, I continue to look at opportunities. The amount of alternative investment in the insurance portfolios is expected to increase as the legacy property portfolio winds down. While AXA IM is the first port of call, especially for investment propositions where they have an established presence such as commercial real estate debt, there is flexibility to consider other managers if that is beneficial to members.

Infrastructure (debt and equity) is probably the sector that I am most actively examining right now. Private equity is an interesting one – I think there is a very strong case to be made, and the regulator has brought in a more favourable framework for how private equity investments can be treated under Solvency II, with the industry gradually adapting. The main obstacle for investing in private equity, in particular for a small insurer in the UK, is management of the currency exposure: as far as I know there are no funds offered in sterling (mainly US dollars) and, while it is possible to set up a currency hedging programme, it does add costs and operational complexity for a very lean in-house team.

Q: You’re currently exploring the subject of climate change, with new responsibilities in this area. Could you tell us a little about this?

This is a fascinating and very challenging space. If I may draw a parallel, a very loose one, it reminds me of the rise of the internet – something which had significant, disruptive and largely irreversible effects, with huge impact on both the supply and the demand side of the economy, from value chains to consumer behaviour. The economic outcomes driven by climate change are very hard to predict. This makes it hard to determine the best course of action from an investment portfolio perspective, other than taking obvious steps such as not investing in coal mining companies. AXA IM adopts a policy of exclusion, to which Foresters have signed up. I will be thinking about this topic closely during the coming year.

As small-to-mid-sized insurers pursue greater portfolio sophistication in areas such as dynamic asset allocation and private market investment, we will continue to watch Foresters’ progress with interest.

Disclaimer: bfinance is a provider of manager selection services to Foresters Friendly