ETF Use by Insurers, with Ben Woloshin of SSGA and Raghu Ramachandran of S&P Dow Jones Indices

Stewart: Welcome to another edition of the podcast. I’m Stewart Foley. I’ll be your host. We’ve got a great topic today. And just to start it off, in 2022, insurance company holdings in Exchange Traded Funds experienced a significant drop of over 23% or $11 billion. That is the first drop of its kind since insurers began investing in ETFs in 2004. And that’s what we’re going to talk about today: insurance companies and their use of ETFs, and we’re joined by Ben Woloshin who is the head of SPDR Insurance at SSGA. Ben, welcome. Thanks for being on.

Ben: Pleasure, Stewart. Nice to be back.

Stewart: And we’re joined by Raghu Ramachandran, who is the Head of US Insurance Asset Channel at S&P Dow Jones Indices. Raghu, the man that only needs one name known throughout the industry. Welcome man. How are you? Thanks for being on.

Raghu: Yeah, thanks for having me. This is great to be here.

Stewart: So for the four or five people in the insurance world that don’t know you two, could you please give me just a little bit of background on each of you, so that folks can recognize your voices and they’ll know who’s speaking when we’re talking about what. So Ben, if you would start us off. A little bit of background and we’ll go to Raghu.

Ben: Sure. So born and raised in Chicago, although I’ve been living out on the East Coast for a number of years. Professional background, I’ve been in the industry for over 30 years, the last three of which have been at State Street Global Asset Management in the SPDR unit, working closely with US insurance company general accounts. Previous to that I was in another ETF issuer in a similar role and have worked both within the four walls of insurance companies and asset managers for the bulk of my career, both here in the US and internationally as well.

Stewart: And Raghu, how about you?

Raghu: Hi, Raghu Ramachandran, Head of the Insurance Asset Channel and S&P Dow Jones indices. I grew up in Dallas. My wife likes to say I’m more cowboy than Indian. I probably shouldn’t say that.

Stewart: No. It’ll make it through our compliance.

Raghu: So my background is: I was a quant, I was, even worse, I was a fixed income quant, then I was a portfolio manager. Worked at several insurance companies, and ended up being CIO of a couple. And then I’ve been at S&P Dow Jones for about seven, eight years. I’ve been writing this paper on ETFs and insurance accounts for about seven years. I’ve been at S&P a little longer than seven years. Let’s see what else. I also wrote a paper on volatility management, that is on two SOA exams, so for anyone who’s listening, who has to take those and read my paper, apologies ahead of time.

Stewart: Wow. And I swear to you, I think you’re one of the best-known guys in the industry. I don’t know anybody who doesn’t know you, by your… It’s like Cher, everybody knows you as Raghu and that’s it. So we’re thrilled to have you and you are well-known for this paper. We’ve actually carried a version of the paper as well on our website, but you cover, first of all, insurance companies have embraced ETFs without a doubt. There’s a lot of good reasons to hold ETFs, but there’s reasons why they went down in 2022 and I know you’re going to cover that. So can you give us some highlights of your 2022 survey and start us off from there?

Raghu: Okay. Yeah, certainly. So as you mentioned, for the first time since insurance companies have been buying ETFs into their general account portfolio, there was a significant draw-down. Part of it is valuations. So we had the worst bond market in a generation, pretty bad equity market also. So of the $11 billion, about $7 billion of that is just valuations. Markets are down, valuations are down, the EM‘s down. The other $4 billion is outflow, so insurance companies taking money out of it. But there’s an interesting story there also in that of the $4 billion in outflows, probably another half of that are from two companies coming out of equities, and that was an asset allocation decision to allocate out of public equities. So they sold all public equities including ETFs. So that has really nothing to do with the ETF mess of it, if you will. It just has to do with the fact that they made asset allocation decisions in ETFs, which are part of that.

So about half a billion, $600 million of the flows were just people selling ETFs. And I think part of that probably has something to do with liquidity and we’ll get into that, but we’ve seen in the past that, 2020 for instance, when there’s a market stress event, insurers, other people find liquidity in the ETF market faster than they do elsewhere in the market. So that had something to do with that. And in fact, the two mega companies that sold out were P&C companies. If you look at all the other P&C companies, they actually added to equity ETF. So it’s just big companies make a big move and that’s what happens with that.

Stewart: And Ben. There’s some things about this that interest me with regard to the number of transactions versus the number of holdings, which gets me to the question of: how are insurance companies using ETFs? Are they using them as strategic holdings? Are they using them for placeholders? The SPDR group is a leader in this space, you know it well, what can you tell us about how insurance companies are actually using ETFs?

Ben: Yeah, so ETFs are… I’ll approach it from two angles, Stewart. One is there’s a number of use cases for ETFs. One might be interim beta. Say an insurer wants to buy high yield securities and they can’t source a full allotment from their traditional broker-dealer, they might use a high yield ETF for a short period of time just so they’re not sitting on cash. Of course, sort of parenthetically, cash isn’t so bad right now, but historically it could have been used for interim beta.

Another might be scale and subsidiary accounts. A lot of insurers have small subsidiaries in various domiciles and an ETF or a portfolio of ETFs can help create scale in a subsidiary account, so if the subsidiary account is subscale, defined however the insurer wants to do that, rather than having in some instances hundreds of line items, the ETF or portfolio of ETFs can be 3 to 5 to 10 line items, so it makes it much easier to manage.

The third is, of course, a core holding. So we see many insurers using ETFs as core holdings, whether that might be in the fixed income space, from a hard-to-source type of security, like an emerging market debt product. Or it might be a way to express a view in terms of the S&P, for example. And on that note, I like to say in the ETF ecosystem you can really, as an investor, you can source product in really many vertical and horizontal slices of many different markets. So the ETF may be a means by which to express a view in a particular segment or asset class, or just an asset class in general, as I mentioned before.

Stewart: That’s really helpful. And Raghu, what would you like to add to Ben’s comments?

Raghu: Yeah, I think Ben was getting at a point that I think is probably misunderstood. People think ETFs are passive investments. That’s the vehicle itself. You can actually use ETFs actively. So as Ben was saying, you can take positions within a particular sector or a particular asset class. That’s one use for it. I think one really interesting use for it is to do a risk barbell. So if you’re a believer in active management and you say, “Okay, I’m going to be an active equity manager”, obviously for an institutional investor, there are boundaries around that. So you have a risk budget that’s allocated to that. But what you can do is say you can take 60% of your equity allocation, put that in a passive investment, like SPY, and then take the remainder, give it to your active manager, but then give them the entire risk budget, so they can actually really actively manage that without having these constraints. So there’s two ways… So ETFs are passive, but they don’t have to be used passively.

Stewart: That’s interesting. And while we’re on this subject, when you think about insurance companies’ ETF use, what’s the split, equity to fixed income?

Raghu: So about 60% of insurance assets are in fixed income, but it’s the complete opposite in terms of ETFs, that is most of the ETFs used by insurance companies are in equities. I think there’s two reasons for that. One is the capital charge. So initially all ETFs were treated as equity, so buying an equity versus an equity ETF, there’s no difference. Didn’t make sense to buy a bond ETF and get an equity capital charge to that. The NAIC changed those regulations and then coincident with that or maybe driving that change was the evolution of a fixed income ETF market. ETFs started in the equity space. They’re very well-developed there. We’ve now seen a growth in the fixed income ETF space, so there’s actually stuff to buy and people can use.

Stewart: And Ben, when you think about, outside of SPY on ETF use, what else are insurance companies holding?

Ben: Yeah, so what we see is it’s obviously very similar to what Raghu mentioned in terms of equity usage and it really just depends on the insurance company. One of the things that we see a lot of and even during equity market volatility is deploying assets to sectors. And so when you look at Raghu’s paper, you’ll see some reference to this. And so building on Raghu’s point about using passive products to make active decisions, the question comes in: how can a sector enhance their core holdings? And sectors, again to Raghu’s point, are a very powerful portfolio construction tool, and as economic variables and business cycles impact segments of the economy, sector-based investment strategies can help align and adjust portfolios based on macroeconomic or thematic trends, shifts in stock fundamentals, technical indicators such as momentum and the transparency of sector-based ETFs means that you can implement sophisticated strategies with very great precision, back to my point about buying or investing in really any vertical or horizontal slice of a market.

So we’re seeing more insurers utilizing ETFs and sector ETFs specifically as a way to express a view on particular sectors, just as example, insurance. So there’s sector products that invest in insurance companies, financials, technology is a big one, as you’ll see from the paper, and utilities. And one benefit, of course, that may be a characteristic of a sector ETF is yield, especially utilities and financials.
And then the last thing I’d really mention, second to last thing I’d mention, is that we’ve done a lot of work on how to construct sector portfolios and just very high level… There’s four basic things to consider. One is top-down, channelized business cycles. Two is thematic, which is surveying macroeconomic data bottom up, which speaks for itself, and then technical. And then the other interesting thing is that there’s nearly half a trillion dollars from the larger ETF sponsors in sector strategies. And they’re very liquid exposures, which is something we spoke about on the last podcast, which really helps gain better execution. And then lastly, just outside of the sector space, we are seeing some momentum, not a factor, but just an investing trend into convertibles and preferreds as well. And then I would also mention, to the earlier point about the NAIC, preferreds, although preferreds stock, also several of them do have NAIC designations as well, so there’s some decent capital treatment as a result of that.

Stewart: That’s really helpful. So we’ve talked about 2022. Raghu, let’s talk about 2023, year to date view on insurance company usage and what you’re seeing as we move forward here.

Raghu: Yeah, so we’re unfortunately hobbled by the fact that there’s a delay in reporting, so we just have first quarter numbers. Obviously second quarter hasn’t ended also, but so through the first quarter, we’ve still seen significant flows or… It obviously varies, because a lot of stuff happened in the fourth quarter, but through the first quarter, we saw $3 billion come out of the insurance portfolio and most of that again came out from equities. We saw the P&C companies took out another $1.7 billion out of equities. Life’s almost none, it’s like a couple of hundred million. And then on fixed income, we saw another billion and change come out, so companies are still selling. I think one aspect of that is the liquidity of that. You see, again and when markets… March was pretty volatile, and when you have trouble with markets, about the only source you can go for liquidity and actually also about the only place you can go to get accurate pricing for bonds is the ETF market.

Stewart: It’s so interesting to me how, when you start talking about liquidity and it’s a topic of conversation on more podcasts than not, how the ETF structure can actually assist on the liquidity side. Ben, when you look at it, 2023, can you talk a little bit about what you’re seeing. In particular, I think there’s perhaps some regulations that you want to touch on as well.

Ben: Yeah, and a couple of things. One is just echoing what Raghu mentioned and you just mentioned, Stewart, is there’s definitely an overweight to liquidity. We had one client that we were speaking to and basically, the sentiment was, in quotes, “We’re getting paid to wait, and so we’re going to move towards shorter duration of vehicles on the fixed income side.” Where we’ve seen an interesting proliferation as a result is into treasury bill ETFs, that those have grown really rapidly. And so again, clients, institutions, et cetera are getting paid to wait, so the treasury bill products have gained in prominence.

With that said, we are seeing some investors that do want to add some risk across the board. And one interesting way to do that is to get some credit exposure, while maintaining a shorter duration profile in short duration, high yield products. So we’re seeing allocation into those types of products. The larger, more established ones in that space are highly liquid. They tend to have a higher Sharpe ratio than traditional high yield strategies. And the category has demonstrated outperformance in periods of rising rates as well.

And then the last thing, on the product side anyways, given the inversion of the yield curve, we’re also seeing allocations into one-to-three-year corporate bond ETF exposures, which has been interesting. So that’s also been a popular spot for insurance companies and other large institutional investors. In terms of use cases, during this period of time, we’re actually seeing, I’ll call it a proliferation of securities lending, which has been really interesting, with certain asset classes, especially when you see certain types of institutions that are expressing a view on the short side, someone has to be long. And so institutions have been, insurance companies specifically, lending out shares, where it’s beneficial to them, lending out shares of the ETFs that they hold on their books. And then the other interesting thing that we’re seeing are spread lending programs from sources such as the FHLB.

On the regulatory side, a lot of our time is spent working with various state regulators, talking to them about the efficacy of the ETF as an instrument and regulators are very open to the conversation. I believe we discussed last time, New York, at the end of 2021, adopted bond-like treatment for fixed income ETFs, which clients were overjoyed at. We obviously were happy, the industry was happy with that as well. And then starting in July, there was a bill signed in Iowa on April 28th, which is effective July 1st, for life insurance companies only, that defines SVO listed fixed income or preferred stock bonds as not an equity interest. And then we’re working with various other states as well in that regard. And again, it’s another tool, I think as Raghu mentioned, it’s just another tool for insurance companies to take advantage of and from a financial instrument perspective, and obviously if the regulatory capital treatment is going to be favorable or comparable I should say, to the equivalent fixed income, our clients have been pretty thrilled with that.

Raghu: Stewart, if I could add one more bit of color to a point that Ben made on securities lending rates, so insurance companies have been lending equities for a long time. You can lend equity ETFs. One thing that’s really great about fixed income ETFs is now you can lend fixed income. So if you take JNK, a high yield and then you lend it, so you’re getting high yield. Yield plus income from the lending program and there was no effective way to lend bonds until you got ETFs.

Stewart: That’s a really, very good point. And it just serves to bolster the net investment income of insurance companies, which is a… There’s a win. If I was to editorialize here just a little bit, it seems to me that if we could get state regulators to give that look-through provision, it would potentially be helpful. It just seems to me that, for smaller insurance companies in particular, would make a lot of sense for them to own the ETFs and get look-through, which would allow them to get a good execution and very efficient diversification. Not putting you on the spot here necessarily, but do you agree generally that that would be helpful?

Raghu: Yeah, I think you already see that, and I’ll let Ben talk more about the regulatory part of it, but we already see that in the data. So we break the insurance companies by size. So small, medium, large, mega. Mega and large companies hold more ETFs, but that’s just because they’re bigger. But if you look at ETFs as a percentage of invested assets, it’s inversely proportional to the size of the company. So the small companies actually hold more of their assets in ETFs as a percentage of invested assets than do larger companies.

Stewart: Ben?

Ben: Yeah, I would agree with that. And I think as a use case and a tool for the insurers, it’s an educational process, just like in… I wouldn’t call ETFs new, because they’ve been around for decades, but for many new institutional clients, including insurers, they’re a new tool. So we have a high degree of receptivity across the different segments within insurance. And then the other thing I’d mention, just to add onto that, is that we do see a lot of OCIOs, for example, using ETFs as tools in their separately managed accounts as well.

So to the extent there’s a smaller insurer that outsources most of their assets to a third party, within the investment management agreement, they’d build in the ability to use ETFs as well. And a side point, but related, is that even if an insurer is outsourcing a good percentage of their portfolio, we see many insurers still using ETFs to manage cash to gain scale and maybe a smaller subsidiary account that the OCIO is not managing and other uses as well. So they might have a smaller investment department, as a result of outsourcing, but that investment department, in other words, is still using ETFs as a tool.

Stewart: And from the podcast that you and I did with your colleague a few months back, the thing that I was struck with is that if I’m a CIO, and maybe I don’t know as much about ETFs as I should or as I want to, so your colleague actually will go in and help somebody design a program to put on a particular position. It’s not like somebody’s just completely on their own, if they need some advice about how to get something done, you have resources to help folks, right?

Ben: We do, and so we have a robust capital markets team. Most of them have sell-side experience, so they know what’s happening across the street, so to speak. And basically, our role as an ETF issuer is to sit in between the street and the actual buyer, our interest is to see that the client gets the best execution and has a good experience using the tool. And so we do pre-trade analytics, so if a client is looking to put on a position in a particular product, we can do some analytics and perhaps see who is axed on the street for that particular ticker symbol, SPDR ticker symbol of course, or just generally give a view on what’s happening on the street with that particular ticker symbol. The other thing we do, and I realize not everyone has access to Bloomberg, but we probably, in the insurance channel, have 30 open chats on Bloomberg. So if a client is looking to execute something, they can just throw their question in a chat and then we’ll get back to them with speed and alacrity.

Stewart: That’s great. So we’re getting down to the end of the podcast here. So Raghu, what would you want our audience to take away as you look forward here from where we sit today with insurance companies and ETFs?

Raghu: Yeah. In talking to insurance companies about one thing that I think isn’t particularly clear is ETFs are not a new instrument. It’s just a tool to allow you to do whatever expression you want me to do. If you want to buy high yield, it’s a tool to buy high yield. You’re not buying something different. I think especially, a couple years ago, when we first started doing this, people were thinking, “Oh, it’s like a CDO and it’s some sort of structured vehicle that could blow up and I have to worry about risk.”. ETFs are about as transparent as you can get. It’s a question of: you have a new widget, you’re going from a handheld screwdriver to an electric screwdriver. It’s just a new tool. You’re not buying anything different when you’re buying an ETF. You’re buying exactly what you were buying before. It’s just a new tool that allows you to manage portfolios better.

Stewart: Thank you. Ben?

Ben: Yeah, on that note, from a portfolio management perspective, the tool is there to enhance the portfolio manager’s experience. And so to the extent the portfolio manager’s job is security selection, the ETF really helps them do that better. And the industry in general, and our firm in particular, we’re here to educate and help, as I mentioned in my last set of comments, understand the tool better, what the use cases are, help on the regulatory front, and then also educate on the various exposures. We also do believe very much in client-driven innovation, which sounds a bit like a set of buzzwords, but what I mean by that is that if a portfolio manager, CIO, et cetera is touching money, we learn a lot from our clients as well. So we like to take the feedback, understand what clients are looking for, and that way we can enhance the experience, both from a trading perspective, also from a product development perspective as well. So we really do view ourselves as partners and stand ready to help wherever possible.

Stewart: That’s fantastic. Okay. Real quick, before we go, Raghu, who would you most like to have lunch with, alive or dead?

Raghu: Shakespeare.

Stewart: Wow, there you go. I heard somebody say not long ago that there’s still a book a day written on Shakespeare. Isn’t that crazy? How about you, Ben?

Ben: That’s a good question. So alive or dead, I think Barack Obama actually.

Stewart: Wow. There you go. Very good. Good choices. Thanks for being on. Ben Woloshin, who is the head of SPDR Insurance, and Raghu Ramachandran, Head of Insurance Asset Channel at S&P Dow Jones Indices. Guys, thanks for being on.

Ben: Thank you.

Raghu: Thanks. Thank you.

Stewart: We’re thrilled to have you. Thanks for listening. If you like us, please rate us and review us on Apple Podcast. My name is Stewart Foley and this is the podcast.

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