Apollo And Blackstone Pick Insurance As Their Next Bet To Disrupt Wall Street
February 2, 2018 by Antoine Gara
Private equity moguls Leon Black of Apollo Global and Stephen Schwarzman of Blackstone Group are likely to solve a brewing liability crisis way before they get their hands on the American 401k retirement system. That’s the takeaway from Apollo and Blackstone’s somewhat unheralded push into the insurance market, a move that’s likely to be a major growth driver for both heavyweight firms in 2018.
Apollo was first to spot the opportunity in insurance coming out of the crisis, when it decided that managing portfolios of insurance assets like annuities could be a steady source of capital to invest. The business, called Athene, is now publicly traded and carries some $85 billion in assets, roughly a third of Apollo’s overall AuM.
The merit of Athene has only grown over time.
First a unique permanent capital vehicle, it is now an in-demand solution to a big issue facing insurers: How to survive today’s world of quantitative easing and rock bottom interest rates. These conditions mean there’s a dearth of high-yielding safe assets, especially in liquid markets for government bonds and investment grade corporate bonds. Look to the yield on recently issued 10-year Portuguese government debt, or covenant-lite high yield bonds as an example. Those claims aren’t even likely to be “safe” over the long run. It all means insurers are finding it hard to invest policyholder assets that earn the income to meet future claims.
In comes Athene and its fit with the rest of Apollo.
Athene’s managers have shown the ability to hunt for yield outside of liquid fixed income markets where the picking is thin. It’s bolstered returns by building and managing portfolios weighted to less liquid and higher yielding debts, for instance collateralized loan obligations, real estate credit, and private credit. In these markets it is security selection, sector selection and deal flow that can differentiate investors like Apollo. The firm, which manages its own private equity, credit and real estate funds, also offers other advantages. Of Athene’s $85 billion in assets some 22% are subadvised or invested in Apollo’s own funds.
At first seen by some as risky and complicated, Athene is now gaining mainstream acceptance.
In December, Voya Financial divested its $35 billion book of closed block variable annuities to Apollo and other funds, having had a hard time managing the assets and their future claims in today’s market. Voya also will sell $19 billion in individual fixed and fixed indexed annuity policies to Athene. When the deal closes, Athene’s assets are poised to eclipse $100 billion. Apollo believes the Voya deal can be a model from which other insurers and annuities providers divest assets they are having a hard time managing. After all, Voya’s shares shot up in the wake of the Apollo deal.
For decades, Wall Street’s gambit in insurance was to write policies and use the float as a source of capital for new investments. It’s a staple of Berkshire Hathaway and copycats like Markel and Leucadia National; some hedge funds like Third Point and Greenlight Capital have built permanent capital reinsurance vehicles.
Apollo’s concept takes an entirely different tact, instead acting as an investment manager for annuity and other insurer-originated assets that will have to match liabilities. Others, like Blackstone, are finding a strong fit with their own mammoth platforms.
In November, a Blackstone-backed entity called CF Corp. closed the $1.8 billion acquisition of annuities provider Fidelity & Guaranty Life, in partnership with Fidelity National Finance. In January, it hired Chris Blunt the former head of New York Life’s investments group to build out a business called Blackstone Insurance Solutions, which is designed to help “firms meet long-term policyholder obligations.” The moves are an opening salvo for Blackstone, which has built out $100 billion-plus asset businesses in both real estate and credit since the financial crisis.
Take it from Stephen Schwarzman, who said the following on Blacktone’s Thursday earnings call.
We have more promising large scale new initiatives underway today than ever before in our history. For example as Tony mentioned, a few weeks ago we launched Blackstone Insurance Solutions under the leadership of Chris Blunt, the former president of New York Life Investments Group. There is an estimated $23 trillion, that’s with a T, of insurance assets globally, a vast largely, untapped market for us and for just about anybody else, except strictly high grade sellers of product.
Chris will lead the effort to provide a range of the bespoke investment solutions from high grade private credit to traditional alternatives, including the option for full outsource management of insurers investment portfolios. We are exceptionally well-positioned to address this market and I believe we can build a business well in excess of $100 billion of AUM over time.
We’re off to a great start with the $23 billion portfolio and investment management agreement with Fidelity & Guaranty Life, a portfolio company in our tactical opportunities area, as well as our Harrington partnership with Axis. The prospects to significantly grow this business as another great source of capital for the firm are compelling and in just one part of a broader multi-dimensional insurance strategy. Most insurance companies have very small allocations to alternatives today, and we’re confident we can create solutions to lift their returns for their combination of products and scale.
If Wall Street is just beginning to see the power of Apollo and Blackstone’s new might in markets like credit and real estate, it is pretty clear insurance-related assets are next. Here’s what Blackstone’s Tony James added:
[T]he first thing we’ll do is be able to offer them higher returns at a lower risk to our core products, and of course those are – those will have the usual fees and carry that we usually charge.
The second thing is they’re all short of private credit-worthy assets, so investment-grade private assets. Why private? Because private debt for the same credit risk trades – yields a significant yield premium, and that yield premium is very important to them. For the most part, insurance companies do not have their own origination. We have origination. That is what GSO does. It’s what are our real estate debt business does and so on.
And, in fact, in our equity businesses, we’re creating the very kind of paper that they want, but instead of having a place and a set of investors to give it to, we’re selling it into the market. So we’re already creating billions and billions of paper that they’re short and we’re long. So it doesn’t take a genius to put those two things together.
Thirdly, we’re able to – we have some – we worked on this for some of our existing insurance clients. We have several proprietary structures that other people have not done that embed our products in structures which give much better regulatory and rating capital treatment for our kinds of products.
No one else is doing this. Frankly, no one else has the mix and the breadth of products to do it. And so we bring this new technology to the insurance companies that allow them to put a lot more of their balance sheet into our products than they otherwise could without hitting their ratings and capital.
So I think we have a very, very powerful product mix, and I think this could be huge over the years.
If Schwarzman and James are excited about insurance, one day they dream to manage ordinary 401k funds, solving what they believe is a brewing retirement crisis in the United States. It is “going to happen,” James told analysts. For now, in insurance “there is a gap you can drive a truck through for us,” he says.
On Thursday, Apollo and Blackstone reported their full year results that affirmed why their shares sit at multi-year highs.
In broad stokes: Apollo generated $1.1 billion in management fees and $1.5 billion in carried interest and transaction fees from its $248 billion in assets under management. At Blackstone, the numbers were larger. It’s $434 billion in assets under management generated $2.7 billion in management fees and a further $3.7 billion in performance fees. By the way, this is just what investors in the public general partnerships earn. After all, Blackstone invested a total of $50 billion and returned $55 billion on behalf of its limited partners in 2017.
Due to management and performance fees, Apollo’s public shares earned distributable earnings after taxes of $2.37 per share. For 2017, it paid out 87% of these profits to investors, or $2.06 a share, in the form of dividends. At Thursday’s closing prices, Apollo carried a dividend yield of 5.5%. For Blackstone, distributable earnings per share after taxes were $3.17 and the firm paid out 78% of these profits to investors via $2.70 a share in dividends, thus it carried a 7.4% dividend yield.
Bottom Line: Annuities providers and insurers are likely to turn to Apollo and Blackstone to solve their yield challenges in 2018. Stock investors should also take a look: With both firms realizing profits from a new batch of investments and continued growth in assets (and management fees) for the foreseeable future, investors may find safe yields coming from these firm’s public shares.
