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Use of ETFs by Mutual Insurance Companies - 2018

ETFs in Insurance General Accounts – 2018

Degrees of Difficulty: Indications of Active Success

Carbon Scorecard: May 2018

Corporate Carbon Disclosure in Asia-Pacific

Use of ETFs by Mutual Insurance Companies - 2018

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Raghu Ramachandran

Head of Insurance Asset Channel

INTRODUCTION

S&P Dow Jones Indices recently published a comprehensive study on ETF usage in insurance company general accounts,1 showing Mutual insurance companies used ETFs more than other types of companies. In this report, we analyze the investment trends within the mutual insurance industry and compare them against the remainder of the insurance industry.

The National Association of Insurance Commissioners (NAIC) requires all U.S. insurance companies to file an annual statement with state regulators. This filing includes a detailed holdings list of all securities held by insurance companies. S&P Global Market Intelligence (SPGMI) compiles this data from the NAIC and makes it available in a usable format. We use this database to extract current and historical insurance ETF holdings. In addition, First Bridge, an ETF data and analytics company, provides a list of U.S. ETFs as well as characteristics of each ETF—such as asset class, stock strategy, bond credit quality, etc. We combine First Bridge classification information with the statutory filing data to gain insight into how insurance companies use ETFs.2

OVERVIEW

As of Dec. 31, 2017, Mutual insurance companies owned USD 7.2 billion of the USD 27.2 billion in ETFs owned by all U.S. insurance companies (see Exhibit 1).

As a proportion of all companies, more Mutual companies have invested in ETFs than non-Mutual companies. Mutuals also invested a higher proportion of their admitted assets in ETFs (see Exhibit 2).

While Mutuals started using ETFs earlier than other insurance companies and have continued to increase their ETF allocation, other companies have begun to invest more significantly in ETFs. In 2017, Mutuals increased their ETF usage by 19% year-over-year, while non-Mutuals increased their usage by 45% year-over-year. Indeed, for all periods—1, 3, 5, and 10 years—non-Mutuals exhibited a higher compound annual growth rate (CAGR) for ETF adoption (see Exhibit 3).

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ETFs in Insurance General Accounts – 2018

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Raghu Ramachandran

Head of Insurance Asset Channel

INTRODUCTION

Insurance companies first invested in exchange traded funds (ETFs) in 2004. Since then, companies have continued to increase their investment in ETFs, both in terms of absolute amount and as a proportion of the admitted assets. This third annual analysis of ETF usage in insurance general accounts shows the breadth of the usage of ETFs by insurance companies.

The National Association of Insurance Commissioners (NAIC) requires all U.S. insurance companies to file an annual statement with state regulators. This filing includes a detailed holdings list of all securities held by insurance companies. S&P Global Market Intelligence (SPGMI) compiles this data from the NAIC and makes it available in a usable format. We use this database to extract all insurance ETF holdings, both current and historical. In addition, First Bridge, an ETF data and analytics company, provides a list of U.S. ETFs as well as characteristics of each ETF—such as asset class, stock strategy, bond credit quality, etc. We combine First Bridge classification information with the statutory filing data to gain insight into how insurance companies use ETFs.

OVERVIEW

As of year-end 2017, U.S. insurance companies had USD 27.2 billion invested in ETFs. This represented a tiny fraction of the USD 3.4 trillion in ETF assets under management (AUM) and less than half of 1% of the admitted assets of U.S. insurance companies.

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Degrees of Difficulty: Indications of Active Success

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Fei Mei Chan

Director, Index Investment Strategy

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Craig Lazzara

Managing Director, Global Head of Index Investment Strategy

EXECUTIVE SUMMARY

• Strong theoretical arguments and extensive empirical data support the view that we should expect most active managers to underperform most of the time. But most of the time is not all of the time, and most active managers are not all active managers. So it is reasonable to ask whether active performance tends to wax and wane.

• We examined fund performance in various market environments to see whether certain conditions correlate with better active performance. We found that active managers were particularly challenged in periods when dispersion was low, stock prices rose, and market leadership came from extremely large stocks.

• Active managers seemed to perform less poorly in years when the low volatility factor underperformed. This suggests that managers, as a group, have a tilt against low volatility stocks.

INTRODUCTION: PASSIVE VERSUS ACTIVE

The debate between passive and active investing has a long history, but in recent years it has escalated to the forefront of investor awareness. A summary of the arguments advanced by the advocates of passive investing would include the following.

• Alfred Cowles’ (1932) paper on the unimpressive predictive power of stock market forecasters1

• William Sharpe’s introduction of the Capital Asset Pricing Model (1964)2 and Eugene Fama’s random walk hypothesis (1965),3 providing a theoretical underpinning for owning the market portfolio rather than relying on active stock selection

• Pleas from Burton Malkiel (1973)4 and Paul Samuelson (1974)5 that someone (anyone!) launch a prototype capitalization-weighted index fund

• Charles Ellis’ (1975) argument that the professionalization of the investment management business made consistent outperformance unlikely6

• Sharpe’s (1991) simple demonstration that “after costs, the return on the average actively managed dollar will be less than the return on the average passively managed dollar.” 7

In addition, numerous observers, prominently including our own firm, have followed in Cowles’ footsteps in accumulating empirical data on the performance of active managers.8 The results confirm what theory predicts: most active managers underperform most of the time.

However, while active managers as a group cannot outperform, there’s no theology to say that individual managers cannot outperform, or do so consistently.9 Even if we expect that more than half of active managers will typically underperform, theory doesn’t tell us whether the underperformers will be 51% or 81% of the total. It’s reasonable to ask if there are some market conditions that are conducive to relatively favorable (or, more precisely, relatively less unfavorable) active results.

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Carbon Scorecard: May 2018

S&P Dow Jones Indices is committed to providing transparency to markets and publishing relevant environmental metrics on indices.  A range of metrics reveals the carbon footprint of each index, alongside exposure to fossil fuels, stranded assets, and renewable energy.  A new metric has been added this year: carbon price risk exposure.  This metric, developed by Trucost, helps investors understand how companies, and ultimately portfolios and indices, are exposed to the risk of governments imposing a price on carbon emissions.

KEY FINDINGS
  • Absolute emissions decreased for the S&P Asia 50, S&P Europe 350, S&P Global 1200, S&P Latin America 40, S&P/ASX All Australian 50, and S&P TOPIX 150.
  • In 2017, all indices increased their share of renewable power generation and decreased their share of fossil fuel power generation, with the exceptions of the S&P/ASX All Australian 50 and S&P Asia 50.
  • The S&P/TOPIX 150 had the smallest coal exposure score and is well positioned in the face of punitive climate legislation.
  • The carbon intensity of every index assessed increased in 2017, except for the S&P Asia 50, which decreased its carbon intensity by 26%.
  • In 2017, the index with the highest carbon intensity was the S&P/TSX 60 whereas in 2016 it was the S&P Asia 50.
  • Within the S&P/IFCI, 26% of earnings of the index’s listed companies were at risk from 2030 carbon pricing regimes according to the Trucost carbon pricing model.
  • S&P Dow Jones Indices is committed to providing index solutions that provide choices and reflect low-carbon options. When we compare indices with their carbon-focused counterparts, the low-carbon versions actually outperformed the benchmark over a five-year period in most cases.

INTRODUCTION

The S&P Dow Jones Indices Carbon Scorecard stands as a barometer for the carbon intensity of financial markets today and its relation to the direction of the economy

As regulators strengthen policies that support the growth of “sustainable” economies, the investment community will rely on transparent markets to manage risk and capitalize on sustainable development opportunities.  How companies can adapt their products and services to changing consumer demands and how they are exposed to regulations that seek to put a price on carbon are among the key questions to which shareholders, lenders, and insurers now seek answers.

In addition, financial regulators are moving to embed sustainable finance at the core of capital markets.  Earlier this year, the EU High Level Expert Group on Sustainable Finance, which S&P Global was proud to be a member of, recommended a wide range of policy interventions.  In response, the EU published its Action Plan on Sustainable Finance, which introduced a raft of proposed regulatory measures that will, if implemented, impose greater emphasis on investor duties and transparency in markets.Such moves are mirrored across the world.  For example, the U.S.Department of Labor recently updated its guidance on the integration of ESG in the investment process, and the UK is seeking to strengthen pension regulations.  As such, we have seen increasing market participant interest in understanding the exposure of their investments to a range of carbon indicators.

Understanding carbon risks and their potential financial impact is crucial if we are to avoid sudden and inconsistent write-downs of assets and redirect capital toward activities that are aligned with global climate commitments.  Mandatory and voluntary guidance have acted as a crutch to encourage behavioral change, and it is now considered best practice to report on portfolio exposure to carbon even in markets where guidance is lacking.  Investors with over USD 60 trillion in AUM now report their carbon exposure.1

S&P Dow Jones Indices published its Carbon Scorecard for the first time in 2015 to show the exposure of major global benchmarks to carbon risks.  Subsequent publications show how quickly the market (measured as the largest companies in each region) is transitioning to a lower-carbon economy.

For the first time, we have added two fixed income benchmarks to the 10 equity benchmarks assessed by the Carbon Scorecard to provide a broader perspective on the carbon exposure of global financial markets.

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Corporate Carbon Disclosure in Asia-Pacific

Asia-Pacific (APAC) firms quantify supply chain risks, set science-based targets, and implement internal carbon pricing.

EXECUTIVE SUMMARY

Trucost, part of S&P Dow Jones Indices, assessed the trends in corporate disclosure of carbon emissions to see how companies are managing risks in three important areas: quantifying supply chain carbon emissions, setting meaningful emission reduction targets, and pricing carbon to understand the current and anticipated financial implications of impending regulatory and policy measures.  The headline findings include the following.

  • In 2017, APAC businesses continued to expand their carbon reporting to all-time highs, rising 22% since 2016 and 32% since 2014. However, this reporting varied greatly in terms of depth and breadth.
  • Many corporations, particularly in the health care and financial services sectors, do not fully track the carbon sources that are most material to their business activities.
  • APAC companies lag global companies in modeling Scope 3 emissions to simplify their carbon calculations.
  • Companies in APAC are increasingly setting science-based targets that will cut emissions in line with international efforts to limit global warming to 2 degrees Celsius.
  • Nearly one-half of APAC companies have set or plan to set an internal price on carbon to help understand the risks and opportunities of the transition to a low-carbon economy.

INTRODUCTION

Trucost analyzed environmental data submitted by companies to the CDP annual climate change questionnaire.  Trucost compared data for 2017 with previous years to identify trends in carbon management and reporting, focusing on companies in APAC.  The analysis covered emissions from company operations and use of electricity (Scopes 1 and 2, respectively), as well as value chain emissions (Scope 3) as classified in the Greenhouse Gas (GHG) Protocol.1

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