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Solvency II (SII) investors have, historically, shied away from investing in private equity or special situations due to the high SII capital requirements. We believe that SII is more accommodating to private equity or special situations than many investors may think. SII investors may want to consider moving some of their equity allocation to special situations.
INSURANCE INVESTORS ALLOCATE LESS TO PRIVATE EQUITY THAN OTHER, COMPARABLE, INSTITUTIONAL INVESTORS
According to EIOPA, only 0.7% of insurers assets were invested in private equity (PE) funds in 2020 versus 10.2% in common equity2. This may be due to the higher SII risk capital requirement for private versus common equity3. As a comparison, European pension funds commit almost 3 times as much to PE funds4 even though their assets are less than half of the European insurance asset base5. We believe that SII insurers that follow the standard model could increase their PE exposure to 20% of their overall equity allocation without increasing their SII equity capital requirement.
Determination of the SII capital requirement for a portfolio of common (type 1) and private (type 2) equity
SII capital requirements are covered under Article 169 of the EU Delegated Regulation. Article 169 describes two types of equity. Type 1 equity is described as publicly listed equity that has been listed on an OECD exchange. Type 1 equity has, under the standard model, a capital requirement of 39%. Private equity is part of the category of Type 2 equity and is assigned a capital requirement of 49%.
The equity capital requirement for a portfolio that contains both Type 1 and Type 2 equity is defined as:
The potential diversification benefit described by Exhibit 1 for combining Type 1 and Type 2 equity enables an SII investor to invest 20% of their equity allocation into private equity without any material increase in their equity risk capital requirement.
If we consider the historical returns of a low volatility PE-like strategy, such as Bain Capital’s Global Special Situations strategy (GSS), increasing the allocation to private equity could be attractive to SII insurers for following reasons.
Comparison of returns and price volatility of Bain Capital GSS, PE funds and PME
Bain Capital’s GSS strategy, and private equity funds in general, have exhibited better performance during periods of market distress than the MSCI World. They have also exhibited lower volatility and better Sharpe ratios than public market equivalents (PME). To some extent, the lower volatility reflects a difference in how private markets value their investments relative to public markets. Conservative private asset managers, typically, take market valuations onto account but they focus on the underlying fundamentals in their holdings. For example, changes in earnings or financial leverage. This is in contrast to public markets which generally change valuations based on changes in market demand. This includes, for example, inflating PE multiples or valuing callable leveraged loans above par. The differences in the approaches to pricing are, in our opinion, a reflection of the different characteristics of the underlying securities. Most of the securities held in Bain Capital’s GSS strategies, for example, are bought with the intention of holding an asset until it can be restructured and/or value-enhanced. This is a process that can take several years to execute. PMEs are made up of trading assets where supply and demand fluctates by the minute. In our opinion, the alignment between PE-style offerings and the long-term investment intentions of insurance clients is reflected in the lower volatility of returns.
Please consider the following:
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Discussion of Returns
Notes Regarding Pro Forma Investment Returns
Notes Regarding Pro Forma Bain Capital Special Situations Investment Returns
Investments described in these pro forma returns were held in various Bain Capital investment vehicles which may have applied different economic terms.
1 Represents Bain Capital’s view as of the date of this presentation and is subject to change
2 EIOPA 2020 European Insurance Overview, Feb. 28, 2022
3 Delegated Regulation (EU) 2015/35, Article 169. Type 1 (common equity) has a risk charge of 39% vs 49% for Type 2 (private equity)
4 “Investing in Europe: Private Equity Activity 2020”, Invest Europe, Jul. 7th, 2021. In 2020, Insurance companies made up 10% of new PE commitments vs 29% for Pension funds
5 European insurance AuM was estimated to be € 10,627 Bn as of Dec. 2020 Source: “European Insurance in Figures 2020” Insurance Europe. European pension assets are estimated to be € 4,604 Bn Source: “Pension Fund Statistics and Trends”, Pensions Europe as of March 2020
6 Delegated Regulation (EU) 2015/35, Article 168 (4)
7 Calculated as PE Allocation = [ Capital invested in Type 2 funds/ ( Capital invested in Type 2 funds + capital invested into public Type 1 equity)] Type 2 equity is defined as all other types of equity or commodities including private equity, EU Delegated Regulation (EU) 2015/35, Article 168 ¶3
8 Based on quarterly returns from Q1 2015 to Q2 2022. Sources: Bain Capital Credit Global Special Situations Track record (Net), Cambridge Associates Preliminary Net Returns for North American, European and Asian Buy-Out funds and MSCI World for global equities.. Past performance is not indicative of future results. Actual results may vary. Please see Endnotes for information on performance calculation methodologies and other important additional information.
9 Calculated as Sharpe Ratio = [ Mean LTM Return – (1+3M US Libor Rate)^.25-1)]/[ STD (Mean LTM Return – (1+3M US Libor Rate)^.25-1)]. Based on quarterly returns from Q1 2015 to Q2 2022. So Sources: Bain Capital Credit Global Special Situations Track record (Net), Cambridge Associates Preliminary Net Returns for North American, European and Asian Buy-Out funds and MSCI World for global equities.. Past performance is not indicative of future results. Actual results may vary. Please see Endnotes for information on performance calculation methodologies and other important additional information.