South Korea’s Hanwha Life has changed its investment strategy by boosting spending in domestic bonds as higher foreign-exchange hedging costs make foreign debt less attractive.
This is contrary to expectations that overseas investments by domestic insurers will continue to rise in the search for higher investment returns and longer asset duration to match the asset-liability gap, especially after overseas investment restrictions were loosened in April.
Hanwha, which had 97.8 trillion won ($79.2 billion) in assets under management as of March, has reduced its allocation for foreign bonds from 6 percent to 4 percent in its bond portfolio. The company also used some of its 350 billion won in proceeds from foreign debt sales to buy long-term bonds in Korea.
Until recently Hanwha focused on buying profitable overseas long-term bonds. Since the rates were higher than those of domestic bonds, purchasing them could reduce the duration gap while also ensuring profitability. However, currency hedging costs have emerged as a variable.
Most insurers use derivatives to hedge foreign exchange risks related to overseas investments. The hedging can reduce the risk of loss due to foreign-exchange rate fluctuations but, the greater the volatility becomes, the greater the cost burden rises. A rising exchange rate increases hedging costs as currency swap rates rise.
One of the reasons Hanwha, one of the three big life insurers, went into the red last year was because of derivative-related losses during the currency hedging process. Eighty percent of Hanwha’s foreign currency securities consist of US dollar bonds but the reversal of the US-Korea interest rates caused an increase in foreign exchange hedging costs leading to a lower operating margin. Hanwha had a surplus of 29 billion won invested in derivatives until 2018 but it posted a deficit of 126 billion won last year.
Industry watchers say hedging costs for overseas assets may have increased in the first quarter this year as the Korean won weakened sharply versus the US dollar. Volatility also increased after demand for safe assets soared due to the coronavirus crisis.
“The US Treasury prices rose significantly as its yields fell more sharply than domestic bonds in the first quarter than in Korea,” a financial investment industry source said. “Hanwha must have judged that purchasing domestic bonds is a more profitable investment strategy than holding overseas bonds enduring high hedging costs.” (Reporting by Eun-sol Lee)