When Challenger Limited (ASX: CGF) writes you an annuity; it takes the premium you pay, adds some of its own capital and invests this in a portfolio of assets. These assets essentially fund the future annuity payments that Challenger will owe you over time.
Therefore, the quality of these assets is absolutely critical in ensuring policyholders can be made whole without requiring additional investment by the company’s shareholders. The good news for Challenger shareholders is that we assess the asset quality to be very high and the asset managers at Challenger to be highly prudent.
The following provides a helpful summary of the nature of Challenger’s approximately $11 billion in Life investment assets as of 30 June 2014:
- 72 per cent – fixed income and cash;
- 19 per cent – property;
- 5 per cent – infrastructure;
- 4 per cent – equity and other investments.
Within the fixed-income and cash bucket, the following chart gives a sense of the high credit quality of these assets, based on credit-ratings. (Note: BIG stands for “below investment grade”).
A recent test that Challenger passed with flying colors related to the recent collapse in the oil price. As many readers know, much of the US “fracking boom” has been funded through the high-yield debt markets. Many investors assessed (incorrectly) these high-yield credits as an easy source of incremental risk-free yield; already they have paid the price dearly and the dust has not yet settled. Challenger’s exposure to these credits was immaterial, thanks to its judicious approach to credit risk assessment.
What about highly rated securities which might, just might, incur credit losses one day? After all, this was the story of the GFC. And it is by no means out of the question that some European sovereign bonds or some US municipal bonds might write down their principal repayments one day. Fortunately, again, Challenger’s Life business is not exposed to any of these types of securities.
Overall, while these are absolutely the questions investors should be asking, we are very comfortable with the asset side of Challenger’s Life business.
The Montgomery funds own shares in Challenger.