What if U.S. life insurance and annuity issuers are putting so much of their bond portfolios in the hands of a few asset managers that this trend could crash the U.S. financial system?
Three economists at the Federal Reserve Bank of Dallas raise this question in a recent working paper.
The issuers have entrusted more than $1 trillion in bonds to outside asset managers, and five firms do handle more than half of those bonds, the economists report.
The economists found that, in the real world, the longer two insurers share an asset manager, the more similar their bond portfolios become.
But, over the period from 2006 through 2020 — which included the 2007-2009 financial crisis and the start of the short, severe slump caused by the start of the COVID-19 pandemic — sharing an asset manager had a much bigger effect on bond purchases than on bond sales.
Because sharing an asset manager affects bond purchases more than bond sales, "a large increase in portfolio similarity through shared asset management does not automatically translate to system risk to the broader financial system," the economists write in a summary they prepared for laypeople.
The economists are Ali Ozdagli, Dylan Ryfe and Lillian Han. Their paper is a working paper, meaning that it has not yet gone through a full peer review process.
What it means: Life and annuity issuers' tendency to use the same big, blue-chip bond portfolio managers is a powerful enough economic force to get Fed economists' attention, but it's probably not powerful enough to crash the economy.
The backdrop: Life and annuity issuers had about $8.7 trillion in assets in 2023, and about $8.2 trillion in assets in 2020, according to the American Council of Life Insurers.
Outside managers may have managed $3.4 trillion in assets for all insurers in the world in 2021, according to the Dallas Fed team.
The reliance on a small number of big outside managers "may pose a potential financial stability problem to the extent that it leads to coordinated investment behavior across insurers working with the same asset manager," the economists write.
The analysis: The economists answered the question by measuring the similarity of life and annuity issuer bond portfolios and measuring how sharing, or not sharing, the same asset manager affected portfolio similarity levels.
Even after controlling for many factors that could skew the results, insurer pairs that shared a bond manager had portfolios that were 20% more similar on average than insurer pairs without a shared bond manager.
The similarity of bond trades was 50% higher for insurer pairs that shared an asset manager than for pairs that did not.
"This suggests asset managers not only shape the long-term portfolio strategy of life insurers but also actively influence their trading decisions," the economists write.
Credit: g0d4ather/Shutterstock
© Touchpoint Markets, All Rights Reserved. Request academic re-use from www.copyright.com. All other uses, submit a request to TMSalesOperations@arc-network.com. For more information visit Asset & Logo Licensing.