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Haitong Macro | Liang Zhonghua team
Authors of this report:
应镓娴 S0850521080001
贺媛 S0850123030080
梁中华 S0850520120001
·Investment Essentials ·
This feature is the second in our team's series on broad asset allocation in a low-interest rate environment. In the first part, we compared the performance of asset classes in the US, Japan, and the Eurozone during low interest rate cycles. In this topic, we will examine how overseas financial institutions carry out asset allocation in the low interest rate environment, and focus on the asset allocation behavior of financial institutions such as banking, insurance, and mutual funds.
For banking financial institutions, in the case of a rapid decline in the real estate economy in an economy, if there is no financial crisis in which financial institutions go bankrupt and fail, banking financial institutions can still provide financing support to entities, and the proportion of credit allocation will still increase; However, if there is a financial crisis, the proportion of credit assets will continue to decline, and the proportion of interest rate bonds will increase significantly. After the rapid downturn of the real estate economy, insurance institutions will gradually increase the proportion of interest rate bond assets, and at the same time will increase the proportion of overseas assets to improve the income on the asset side. Insurance financial institutions will also increase the income on the asset side by extending the duration, sinking credit, and investing in alternative assets. The large-scale asset allocation behavior of public funds reflects more the asset allocation preferences of real sectors such as residents and enterprises. In a low-interest rate environment, which fund products are more respected and develop faster? Currency management funds and long-term bond investment funds may be highly respected for a long time, and the scale expansion is more obvious; "Going overseas" public fund products will also develop rapidly, in order to find some higher-yield assets overseas, especially overseas bond assets; Passive allocation index products have also developed well in some markets for a certain period of time; In addition, there are some special fund innovation products, such as Japan's "monthly final account" fund products, which also meet the needs of the elderly for stable cash flow. However, we also want to stress that the mainland's economic growth potential is huge, and the fundamentals of stability and improvement will not change, and when thinking about the allocation of large types of assets, we cannot simply compare them with overseas experience, but must consider the mainland's own special advantages and special circumstances.
Risk warning: lack of understanding of data and policies
In the Low Interest Rate Environment: What Assets to Allocate to? In Asset Allocation Series 1 under Low Interest Rates, we delineate Japan's low interest rate cycle from 1991 to 2019, the eurozone from 2008 to 2019, and the United States mainly focuses on the long-term low interest rate period from 1929 to 1945. This topic also takes these three low-interest rate ranges as the background, focusing on finding clues from the perspective of asset allocation in the banking, insurance and fund industries.
1
Financial Sector: Reduced holdings of loans, conversion of securities
First of all, from the asset side of the overall financial sector, after entering the cycle of low interest rates, especially after the financial crisis led to the large-scale bankruptcy of financial institutions, the proportion of loans allocated by the financial sector will continue to decline. On the one hand, this is due to the increase in credit defaults in the real sector, which will lead to write-downs of real debts; On the other hand, due to the decline in the demand for physical financing, the risk appetite of financial institutions will also decline, and the credit creation process tends to slow down. In addition, Japan's financial sector has been increasing its allocation to bond-like assets since 1990, and has shifted to increasing the ratio of cash and deposits since 2012. After the decline in interest rates in 2008, financial institutions in the euro area mainly increased their investment income by increasing the allocation of bonds and equity assets, especially the increase in the share of equity and investment funds. During the low interest rate period in the 30s and 40s of the last century, the changes in the asset side of financial institutions represented by American banks were more similar to those in Japan: with the decline in the proportion of loan assets, the allocation of bond investment assets and currency deposits increased significantly.
The financial sector's increased allocation of bond-like assets is mainly government bonds, which is of course also related to the economic downturn and the government's substantial increase in the supply of government bonds to stabilize growth. For example, after the bursting of the real estate bubble in Japan in the 90s, the growth rate of financial institutions' credit investment in the private sector gradually slowed down, and the investment in government departments accelerated significantly; In particular, after the 1998 crisis in Japan's financial sector, the credit allocation of financial institutions to the private sector turned negative, while the credit allocation to the government sector continued to accelerate. After 2008, financial institutions in the euro area have gradually slowed down their credit allocation to the private sector, while their credit allocation to the government sector has tended to accelerate. Therefore, the change in the asset allocation structure of financial institutions is also highly related to the change in the supply side of financial assets. The change in the supply of financial assets is closely related to the financing demand of the real sector. When economic demand is sluggish, private sector financing needs are usually weak, while governments tend to increase financing needs in order to stabilize the economy.
2
Banking: Reducing loans, increasing bond allocation
Next, we start from different types of financial institutions to examine the asset allocation behavior of financial institutions in a low-interest rate environment. In response to the low interest rate environment, Japanese commercial banks have gradually adjusted their assets: 1) The loan ratio has declined, mainly since 1998. At the beginning of the real estate crisis in Japan in the early 90s, there was no trend in the asset allocation of the banking industry: the proportion of bonds was basically stable, and the proportion of loans increased slightly (from 68% in 1990 to 73% in 1996). This is because there was no large-scale financial crisis immediately after the bursting of the housing bubble in Japan, mainly due to the Japanese government's approach of allowing financial institutions to bail out troubled companies and postpone debt problems. Therefore, at that time, the Japanese banking industry did not go bankrupt on a large scale, and it was able to continue to "transfuse" the real economy. It was not until 1997-1998, when Japan's financial crisis broke out, the banking industry went bankrupt and collapsed, and the recognized loan losses also increased significantly, that the banking industry began to reduce the allocation of loan assets, and significantly increased the proportion of bond assets, with the highest proportion of bonds at the end of 2011 reaching 25.6%, an increase of 16 percentage points from the end of 1997.
Since 2011, the share of bonds has declined, replaced by an increase in institutional allocations to money and deposits, or mainly related to the Bank of Japan's large-scale asset purchase program, which directly increased bank deposits and reserves, and reduced the holding of interest rate bonds.
2) Increase overseas asset allocation and explore high-yield opportunities. In addition to increasing the allocation of bonds, the Bank of Japan has also set its sights overseas since 2000. In terms of asset structure, the proportion of foreign portfolio investment increased slightly from 1.6% in 1999 to 5.5% in 2015. In addition to increasing overseas portfolio investment, major banks tend to increase the proportion of loans to overseas, with Mitsubishi UFJ and Sumitomo Mitsui Banking Corporation increasing their overseas lending ratios to 55% and 32%, respectively, as of FY2019. Compared with Japan's long-term low loan interest rate, the economy of some overseas regions has maintained good economic growth, which can effectively help increase interest income.
During the low interest rates of the 30s, the U.S. banking sector replaced loans with increased bond holdings and cash. The share of commercial bank loans fell from 58 percent in 1929 to 35 percent in 1934, and continued to decline in the following decade, reaching only 18 percent in 1946. This was matched by an increase in bond assets and cash allocation, which by 1936 had risen to 33% and 26% of total assets, respectively.
However, in comparison, the asset allocation structure of commercial banks in the eurozone has not changed much. During this period, the proportion of the banking sector in loan allocation decreased by 5 percentage points (2008-2019). The banking sector's allocation to bond assets increased by 3 percentage points from 11% in 2007 to 14% in 2014. In addition, the asset allocation to the external region has not increased but decreased since 2008, and the momentum of eurozone banks' overseas investment is not strong.
Overall, after entering the low-interest rate environment, if there is no financial crisis, the overseas banking industry can continue to provide loan support to entities, and the proportion of loan assets will continue to increase. However, if the financial crisis breaks out, the banking industry will bear the brunt of the financial crisis, and will continue to reduce the proportion of loans and increase the proportion of bonds, especially interest rate bonds and cash. Japan's banking sector also slightly increased the proportion of foreign portfolio investment to boost earnings. Relatively speaking, the behavior of eurozone banks in asset allocation has not changed much. In addition to asset adjustment to cope with low interest rates, mergers and acquisitions will also be used in the banking industry to enhance market competitiveness and improve risk resistance. For example, the "Big Three" of the Bank of Japan, Mitsubishi UFJ Financial Group, Mizuho Financial Group, and Sumitomo Mitsui Financial Group, were reorganized during this period. The formation of large financial groups has also provided strong support for Japan's capital layout and industrial integration on a global scale.
3
Insurance: Japanese institutions "go overseas", Europe increases equity
The liability side of insurance institutions is relatively rigid, and the low interest rate environment puts forward higher requirements for asset allocation. The predetermined interest rate of insurance company products will be subject to competitive conditions and minimum guaranteed interest rates, and it is difficult to adjust quickly as interest rates fall. If the return on investment declines, it will directly compress the spread space, and even produce "spread loss". Therefore, for insurance companies, the long-term low interest rate environment will also bring great pressure, and even the Japanese insurance industry in the 90s once experienced a "wave of bankruptcies".
In order to supplement income, Japanese insurance institutions have significantly increased their allocation to securities. In general, the asset side mainly showed a rapid increase in the proportion of national bonds and local bonds, and the adjustment of loans and equity assets tended to decrease.
1) During the rapid decline in interest rates in the 90s, Japanese insurance institutions greatly increased the allocation ratio of interest rate bonds. This is because during periods of rapid interest rate declines, bond assets can generate relatively substantial capital gains income. Of course, the main increase of insurance institutions is the allocation of interest rate bonds, and the allocation of credit bonds has not changed much. Taking life insurance institutions as an example, compared with the allocation of interest rate bonds that continued to rise from 4% to 49.7% (1990-2012), the allocation of credit bonds has remained stable in the range of 5%-15% for a long time.
As we mentioned earlier, the large increase in the allocation of interest rate bonds by insurance institutions is also related to the supply-side factors of bonds. Since the 90s, the Japanese government has issued large-scale government bonds to finance the economy, and the scale has rapidly expanded from 26 trillion yen in 1990 to a high of 177 trillion yen in 2012, a 6.8-fold increase. However, the willingness of the corporate sector to increase leverage is relatively weak, and Japanese regulators have high information disclosure requirements for the issuance of corporate bonds, which is difficult for ordinary enterprises to meet, so the long-term low supply of credit bonds also restricts the allocation of insurance institutions.
2) In the 90s, the proportion of stocks continued to fall, and overseas securities tended to expand. Specifically, the proportion of equity and investment funds on the asset side of the insurance industry reached a high of 35.7% in 1988 and has been reduced to 7.8% in 2002. In addition to the sharp decline in stock prices during the period, the total value of equity assets shrank, from the perspective of capital flow, in the 90s of the last century, Japanese life insurance institutions also had a net outflow in stock asset allocation most of the time. It was not until 2003-2006 that the Japanese stock market continued to rise, which led to the insurance industry to continue to increase the allocation of equity assets.
We believe that in addition to the continued low and volatile stock yields, the changes in the product structure on the liability side may also restrict the allocation of equity assets. Because in the context of weak economic expectations, the demand for investment insurance products in the market is also decreasing, which makes the demand for stability on the asset side increase.
Since about 96 years, the allocation of overseas securities in the Japanese insurance industry has increased significantly. Looking further, the allocation of overseas securities by Japanese life insurance institutions is also dominated by bond assets, and the proportion of stocks is very low. As a result, the Japanese life insurance industry has been able to achieve higher yields than pure bond investments in most years, thanks to the allocation to foreign securities
3) Lengthen the duration of assets and narrow the duration gap. With the issuance of a large number of Japanese government bonds, life insurance companies have increased their allocation to long-term bonds with maturities of more than 10 years, and in terms of average duration, in addition to the impact of the wave of bankruptcies around 1997, the duration of government bonds, corporate bonds and loans receivable has been increasing. This has also led to a narrowing of the duration gap between assets and liabilities, reducing the risk of mismatches.
In the asset allocation of the low interest rate environment, insurance institutions in the euro area 1) choose to increase the allocation of equity and bond assets at the same time to compensate for the decline in income. Specifically, the allocation ratio of equity and investment funds has continued to rise since 2009, from 29% at the beginning of 2009 to 39% in 2019, an increase of about 10 percentage points. The change in the proportion of bond assets is similar to that in Japan: during the period of falling interest rates, the allocation of bonds has increased significantly; After 2016, the proportion of bond allocation has turned back.
However, the difference in the repair of fundamentals in different regions after the crisis has passed will also affect the allocation strategy of local insurance institutions. For example, the investment of German insurance companies is subject to stricter quantitative supervision, and the asset allocation is mainly fixed income assets, which is relatively conservative. However, thanks to the long-term bullish performance of the German stock market, the proportion of insurance institutions investing in equity assets has continued to grow. In Greece, after 08 years, insurance institutions as a whole increased their allocation of bonds and reduced their allocation of stocks, which is related to the poor performance of the local stock market.
2) Moderate sinking credit. For fixed income assets, in addition to increasing the allocation of long-term bonds to lock in higher yields, eurozone insurance institutions will also moderately reduce the quality requirements of credit bonds in their portfolios in exchange for higher credit risk premiums. For example, Germany's Allianz Insurance Group, on the one hand, has increased the proportion of corporate bonds as a whole; On the other hand, between 2010 and 2019, the company significantly lowered its holdings of AAA-rated bonds (from 46.3% to 19.3%), and increased its allocation to AA-rated and BBB-rated bonds.
3) Gradually increase the allocation of alternative investments. In recent years, these institutions have also continued to explore opportunities in alternative assets, such as Allianz Insurance's allocation to alternative assets exceeded 10%, and AXA's investment in real estate has also trended higher.
In our view, the return on traditional assets under low interest rates is limited, and there may be underexplored investment opportunities in alternative asset areas, such as real estate, PE equity, infrastructure, etc.; On the other hand, alternative assets are often less correlated to traditional markets, which also helps to reduce the volatility and risk of the overall portfolio.
In the United States in the 30s and 40s, insurance institutions also made significant asset allocation adjustments. The share of bond assets rose sharply, from 34% in 1929 to 73% in 1946 after the Great Depression began, while the share of loan assets fell significantly, from 42% in 1929 to about 15% in 1946.
In summary, compared with the banking industry, overseas insurance institutions have been more active in responding to the low interest rate environment, and have generally greatly optimized the structure of asset allocation. On the whole, insurance institutions will increase their allocation of bond assets, especially interest rate bonds, while reducing their loan allocation. For example, Japan has significantly increased its allocation of interest rate bonds, especially long-term bonds. Eurozone institutions have also opted to sink credit to boost earnings. In order to obtain excess returns, the Japanese insurance industry will also choose to expand overseas market investment, especially overseas bond asset allocation; European institutions tend to continue to increase their equity asset allocation, which of course is also related to the performance of European stock markets at that time.
In addition, liability management is also an important part of insurance institutions to reduce the risk of interest rate loss caused by the low interest rate environment. For example, since 1990, the predetermined interest rate of the Japanese life insurance industry has been lowered several times from 6.25% to 2% in 2000, significantly reducing the cost of debt. Institutions are also enhancing their ability to adapt to changes in interest rates by optimizing their product structure, such as introducing more financial products linked to market interest rates.
4
Funds: High proportion of foreign investment, indexation of Japanese funds
Finally, let's take a look at which fund products are more respected and develop faster in a low interest rate environment.
In Japan, investment funds are generally referred to as securities investment trusts. In the early 1990s, when the Japanese stock market was in a downturn, the scale of securities investment trusts did not increase but decreased, and it showed the characteristics of the expansion of bond funds and the contraction of equity funds. Equity funds shrank from 45.6 trillion yen in 1989 to less than 10 trillion yen in 1997, while bond funds expanded from 13.1 trillion yen to 30.7 trillion yen over the same period.
However, since 2003, stock public funds have begun to expand and become the leading force in the new stage to promote the growth of public funds, while the scale of bond funds has stagnated for a long time. By 2019, equity funds accounted for about 90% of the overall public fund scale. During the same period, private securities investment trusts also achieved steady expansion.
In the 90s, the growth of Japanese bond funds was mainly driven by currency managed funds (MMFs) and long-term bond funds. With the decline in the rate of return in the capital market, residents' demand for funds gradually shifted to highly liquid money-managed funds, and the proportion of MMF in the scale of bond funds reached a maximum of 47% in 1999. During the same period, the scale of long-term bond funds also showed rapid growth. Since 2000, as medium- and long-term bond yields have fallen to low levels, medium- and long-term bond funds have gradually shrunk. During this period, the Monetary Reserve Fund, which mainly invests in government bonds and treasury bills with a remaining maturity of less than 90 days, became the mainstream bond-based product. By 2019, money savings funds accounted for 95% of the total bond fund size.
In addition to the adjustment of the asset allocation structure of stocks and bonds, there are three core clues in the development of Japan's fund industry since the 90s that cannot be ignored.
1) Significant reliance on "going global" products to support revenue and scale. In the 90s, the proportion of Japanese fund products in overseas securities investment increased significantly, and by 2010, the proportion of foreign securities investment in the fund industry had reached 59.4%. Compared with the previous banking and insurance industries, the proportion of Japanese securities investment trusts to overseas assets is significantly higher, which also shows that Japanese residents and enterprises want to look for some higher-yield assets overseas.
According to the statistics of the Investment Trust Association, the proportion of foreign currency-denominated assets in Japan's public equity fund products reached about 55% at the peak, and has fallen back to about 30% in recent years (except ETFs); The proportion of bond funds invested in overseas bonds has continued to exceed 50%, and even exceeded 70% at its peak.
In terms of the regional distribution of outbound investment, the proportion of dollar-denominated assets is the highest. Among equity assets, the proportion of U.S. dollar-denominated stocks has been increasing, reaching more than 70% in 2020; Among the bond assets, in addition to the relatively high proportion of US dollar-denominated bonds, the proportion of bonds in the euro area and Australia is also high.
2) Passive allocation products promote the development of Japanese equity funds. In the 90s, the development of Japanese equity funds was relatively slow. However, after 2010, the expansion of equity funds began to accelerate, especially the expansion of passive allocation index products. From 2010 to 2022, the size of index funds increased from 6.8 trillion yen to 80.9 trillion yen, accounting for 82% of the total increase in equity funds during the same period. The size of actively managed funds increased by only 16 trillion yen. The rapid expansion of passive allocation products may be mainly due to the large purchase of ETFs by the Bank of Japan, which has driven the growth of the ETF market. At the same time, the steady rise of the Japanese stock market was also supportive.
3) Characteristic fund product innovation to support the scale of the industry. In order to better meet the needs of residents for financial products, the Japanese fund industry is also constantly promoting product innovation, among which the most influential is the "monthly final account" fund product developed based on the elderly population. Due to the limited fixed income of the elderly, such funds can calculate the net value on a monthly basis and distribute income to investors as agreed, which accurately meets the cash flow needs of the elderly, so it is widely popular in the market. Since 2001, the asset scale of monthly final account funds has grown rapidly, and by 2011, such products could account for 54% of the total scale of public funds.
As for the eurozone portfolio funds, after the 2008 financial crisis, institutions mainly increased their allocation to bonds, and since 2012 they have shifted to equity and overseas assets. Similar to European insurance institutions, as most eurozone equities returned to growth after two rounds of correction in 2008 and 2011, local investment funds were able to increase their returns by increasing their investment in equity assets.
In addition, eurozone fund companies have also significantly increased their overseas investment in a low interest rate environment. The proportion of overseas bonds in the total assets of fund companies increased from 11% in 2008 to 20.6% in 2019, and the proportion of overseas stocks and investment funds increased from 16% to 23%. The proportion of overall foreign investment has exceeded 40%. In contrast, the proportion of overseas assets held by the insurance and banking sectors in the eurozone is lower, and at this stage, the local government mainly shares the external growth dividend through the "going overseas" fund.
In summary, the asset allocation of fund companies in a low-interest rate environment reflects more the asset allocation preferences of residents, enterprises and other customers. The "going overseas" funds in Japanese and European securities investment funds have developed rapidly, Japanese public funds focus on opportunities in the United States, Europe and other markets, and euro area funds prefer Asia, the United States and some emerging markets on the margin. In addition, Japanese institutions have also boosted the development of the local fund industry by seizing the policy opportunities of the central bank and vigorously developing passively allocated index funds.
Risk warning: lack of understanding of data and policies
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