Optimizing Asian US Dollar Credit Portfolios for Singapore Risk-Based Capital Efficiency

• The introduction of the RBC 2 risk-based capital (RBC) regime in 2020 increased the complexity of fixed income portfolio management for Singapore insurers.

• Asian USD bonds continue to be attractive for long-term investors, offering a strong risk-reward profile and serving as a key component of Singapore insurers’ portfolios.

• We show how integrating RBC 2 requirements into active portfolio construction can enhance regulatory capital efficiency for Singapore insurers’ Asia USD credit investments without sacrificing performance or resilience.

• Combining active, fundamentals-driven portfolio management with quantitative capital optimization can help insurers improve return on capital under current and future risk-based capital frameworks in Singapore and beyond.

Under the Singapore Risk-Based Capital 2 framework introduced in 2020, insurers hold capital against insurance, asset, and operational risks. For many insurers, credit spread risk is a key driver of asset risk capital requirements, reflecting the impact of credit spread changes on assets and liabilities.

Fixed income portfolio managers can integrate spread risk capital requirements into their portfolio construction to help insurers achieve attractive returns on capital for shareholders while fulfilling policyholder expectations. This paper demonstrates how to incorporate insurance capital efficiency into portfolio construction for Asia US dollar bonds, a significant asset class for insurers in Singapore and across Asia.

The appeal of Asia USD bonds for insurers

Asian credit, particularly investment grade (IG) bonds, is an appealing asset class for long-term investors and life insurers due to several factors:

• Strong fundamentals. Asia IG corporates exhibit stronger credit profiles compared to their developed market counterparts, with lower leverage ratios.

• Favorable macroeconomic environment. Inflation in Asia is generally under control, and economies are growing steadily.

• Attractive valuations. Asia IG credit offers compelling all-in yields with better risk-adjusted returns. These bonds provide additional credit spread over developed market bonds, while maintaining shorter duration and lower volatility.

• Positive supply-demand dynamics. Reinvestment demand currently surpasses USD bond issuance from Asian issuers. Local investors’ home bias, along with demand from international asset owners, helps stabilize the volatility of Asian bonds.

For a more detailed discussion, please refer to the additional PineBridge insights listed at the end of the article.

Solving for regulatory capital efficiency under Singapore RBC 2

Integrating RBC requirements into active portfolio construction can help insurers use capital more efficiently without compromising investment performance or portfolio resilience.

Figure 1: Credit Spread Risk Capital Requirements for Corporate Bonds Under Singapore RBC 2

Source: Monetary Authority of Singapore Notice MAS 133, issued on 28 February 2020 (last revised on 14 June 2024), PineBridge Investments interpretation and analysis.

Figure 2: Capital Efficiency of Asia USD Corporate Bonds Under Singapore RBC 2

Source: PineBridge Investments analysis based on ICE BofA Asian Dollar Corporate Index (ACOR) profile as of 7 November 2024. Singapore RBC Capital Efficiency is the ratio of index Swap OAS to Singapore RBC 2 credit spread risk requirement estimated by PineBridge based on index rating and duration.

Under Singapore RBC 2, the capital requirement for a corporate debt instrument is defined by the change in fair value under a regulator-prescribed spread stress scenario. These spread stresses vary by credit rating bands and remaining term to maturity. Consequently, the capital requirement for a corporate bond investment depends on its rating, remaining term, and spread duration, while its yield is influenced by fundamental, technical, and quantitative factors.

For portfolio managers, this creates an opportunity to enhance active security selection with numerical optimization. One approach is to maximize portfolio spread (or yield) within a given RBC budget, while adhering to client-specific diversification requirements and constraints. The result is a set of capital-efficient portfolios that improve return on capital for insurance investors, aligning with the portfolio manager’s active views.

This approach can be implemented in two steps:

Step 1 – Identify bonds. Select bonds that reflect active views on sectors, issuers, and instruments

Step 2 – Construct capital-efficient portfolios. Maximize the average portfolio option-adjusted spread (OAS) within a given regulatory capital budget, considering:

• Sector, country, and issuer outlook

• Duration and credit quality targets

• Additional KPIs, such as the insurer’s ESG objectives or constraints

• Diversification requirements, including portfolio weight limits and the desired number of countries, sectors, issuers, and instruments

This process generates an efficient portfolio frontier that integrates forward-looking fundamental credit views with capital efficiency requirements. By using this capital-efficient frontier, investors can quantify the trade-offs between portfolio spread, capital requirements, and diversification, resulting in a fully implementable portfolio tailored to the specific insurer’s needs.

For illustration, consider two Asia US dollar corporate bond investment strategies. One strategy (APAC IG) is fully allocated to investment-grade bonds; the other (APAC IG+) allows up to a 15% allocation to high yield bonds. Both strategies’ capital-efficient frontiers sit above the JP Morgan Asia Credit Index (JACI) IG index and US IG index1 (see Figure 3). This indicates that combining active security selection with capital optimization yields a more attractive return on capital than the indices. The APAC IG+ frontier sits above that of the IG-only strategy: a modest allocation to high yield bonds unlocks higher portfolio spreads within the same capital budget.

Figure 3: Capital-Efficient Portfolio Frontiers for APAC IG and APAC IG+ Strategies

Source: JP Morgan, Bloomberg, PineBridge Investments, Monetary Authority of Singapore as of 7 November 2024. Portfolio OAS/YTW is calculated as the market value weighted average of the option-adjusted spread/yield to worst across all bonds. Portfolio Singapore RBC 2 is calculated as the market value weighted average of the credit spread risk capital amount estimated by PineBridge for each bond in the portfolio based on its rating and duration.

Figure 4 compares the OAS and return on capital (the ratio of OAS to RBC) for two optimized model portfolios against broad market indices. For the model portfolios, the return on required capital is nearly double that on the JACI IG benchmark.

Figure 4: Spread OAS and SG RBC Capital Efficiency (Ratio of OAS to Spread RBC) for Optimized Portfolios and Broad Indices

Source: JP Morgan, Bloomberg, PineBridge Investments, Monetary Authority of Singapore as of 7 November 2024. Portfolio OAS is calculated as the market value weighted average of the option-adjusted spread across all bonds. Portfolio Singapore RBC 2 capital is calculated as the market value weighted average of the credit spread risk capital amount estimated by PineBridge for each bond based on its rating and duration.

Helping insurers navigate investment complexity

Combining an active, forward-looking fundamental approach with quantitative capital optimization can enhance insurers’ return on capital under the Singapore RBC 2 regime. This capital-efficient portfolio construction approach can also be adapted to meet the needs of multinational APAC insurers operating under various risk-based capital regimes across multiple jurisdictions.