Citi Research Multi-Assets analysts Stephen Antczak and Jung Lee show in their recent work, “If I Managed Insurance Money…,” how an insurance fund manager can boost portfolio returns by adjusting the liquidity score.

The authors studied 15 insurance company credit portfolios to determine whether their managers had opted for liquidity in preference to returns, and whether it was possible to enhance returns by working down the emphasis on liquidity.

Observations

– Given their inherent advantage of relatively less rigorous MTM risk sensitivity, the Portfolio Managers should improve returns by rotating the holdings down to somewhat less liquid bonds.

– However, the authors acknowledge that compared to the market average, an insurance portfolio, on average, already held comparatively less liquid bonds, and thereby earned better returns.

Insurance

In the above chart, note that at the 80 percent Portfolio Percentage level, the liquidity score of the broad market portfolio was 49 percent, but that of the insurance portfolio was just 26 percent.

The insurance portfolio to earn higher returns

– This lower liquidity score enabled the insurance portfolio to earn higher returns as shown in the graph below.

2-returns

– The authors feel that there still remained the possibility for simple liquidity adjustments (“unlocking value,” as the authors put it) that could boost returns further.

Rotation and its benefits

The authors tested both highly liquid and normal portfolios for improvement on ROC by substituting a bond with another CUSIP with the same maturity profile but a lower liquidity score. In both cases, the result was a “dramatic” improvement in ROC as shown here:

3-before-after

The way forward

The authors suggest two ways Portfolio Managers could tune down liquidity and turn up profitability:

– The first approach is to specifically change identified bonds to less liquid bonds of the same issuer having better ROC.

– The second method is to substitute a group of named bonds with a single generic instrument such as a CLO.