Japanese insurers have expressed multiple views regarding the practical effectiveness of gold as an inflation hedge. Although some insurers have agreed that gold can indeed serve as an inflation hedge tool, others have argued that assets such as real estate or real estate investment trusts (REITs) and equities related to living expenses are the more natural choices. Moreover, it has been revealed that Japanese insurers currently have limited exposure to inflation risk, and the necessity of hedging against inflation is currently restricted, since the main products of life insurers are fixed insurance products, while the main liabilities of P&C insurers are short-duration products.
Gold brings inflation hedging ability, particularly during times of stagflation risk
20 May, 2024
“Since our main insurance products are based on fixed payouts, exposure to inflation risk is limited only to the business expense portion to calculate EVs”
General Manager
Investment Planning Department
Life insurer
As we previously explored, gold returns and Consumer Price Index (CPI) changes have a historically weak linear correlation. However, the correlation between the two variables becomes significantly stronger during periods of extremely high inflation. In fact, when CPI grows more than 5% y/y, inflation’s correlation with gold becomes stronger than it is with equities and REITs, as can be seen in Appendix III.
“Although gold can be an inflation hedge, other asset classes such as real estate investments, which have both inflation hedging effects and cash flows, are prioritised”
Ex-Portfolio Manager
Asset Management Department
Life insurer
For Japanese insurers, a hedge against inflation by itself is currently not a compelling enough reason to invest in gold, and they would find it challenging to justify gold investments mainly for this purpose. This can be attributed to two key factors. First, while Japan has experienced a prolonged period of disinflation or deflation since the 1990s, it has not had the opportunity to confirm the hedging effect that gold investments could exert under higher levels of inflation. Second, as mentioned previously, Japanese life insurers who offer long-term guarantees have relatively limited exposure to inflation risk, with fixed guarantees being their main product line.
But with inflation around the world, including Japan, stubbornly staying above central banks’ targets, Japanese insurance companies may be forced to consider taking more effective countermeasures against inflation risk. Investing in gold could provide one of the solutions. Moreover, the monetary policy normalisation from the Bank of Japan and growth concerns may pose further uncertainties, such as stagflationary risks – and our analysis shows that gold tends to thrive during such periods.
“Each company conducts ESG negative screening, and such investment product[s] would be eligible for investment if there [were] certification saying that there is no problem from an ESG perspective. On the other hand, investing in the Gold ESG Fund [would] unlikely have a positive impact on ESG ratings”
Ex-Portfolio Manager,
Asset Management Department
Life insurer
Focus 2: Gold not only clears ESG negative screening but can be used to reduce carbon footprint
In recent years, institutional investors globally have become increasingly aware of environmental, social and governance (ESG) factors, with many starting to recognise the significance of sustainability and responsible investments. This trend has been observed among Japanese insurers as well, and each insurer now conducts an ESG negative screening before making any investment. Although for Japanese insurers, the financial return is still the primary factor in investment decisions, the importance of ESG is growing year on year.
Our interviews have revealed that some insurers have concerns as to whether gold investments can clear ESG negative screening due to an unfavourable perception of the gold mining industry, particularly in terms of its environmental impact.
From the interviews conducted, it is clear that there is currently a lack of understanding in regard to the gold supply chain and how it operates responsibly. We believe that the framework developed to reflect the expectations of responsible gold mining, known as the Responsible Gold Mining Principles (RGMPs), can address ESG concerns from insurers. The RGMPs should provide investors with confidence that the gold in which they invest is ethically sourced, and help them to identify responsibly sourced gold that will confidently clear the insurers’ ESG negative screening processes.
In addition, Gold and climate change: Decarbonising investment portfolios, our report in collaboration with Urgentum, published in 2021, revealed that including gold in a diversified portfolio can effectively reduce the portfolio’s carbon footprint without compromising returns. Gold's lack of Scope 3 emissions contributes to this positive impact and is explored in depth in the report. In fact, the positive ESG effect of gold is starting to gain recognition globally, as evidenced by notable ESG funds like the BlackRock Diversified ESG Stable Fund, which allocates 3% to gold. Although Japanese insurers have yet to actively invest in assets solely for ESG reasons, we believe that in the near future the positive impact of gold can act as a trigger to increase their allocation to this metal.
Conclusion
Japanese insurers’ risk appetite for gold investments has historically been tenuous, and there is currently very limited exposure to gold for both life and P&C insurers. Our interviews with industry experts have revealed that even among institutional investors who possess deep asset management expertise there are some perception-based, or even psychological hurdles to investing in gold. These appear to stem from limited information about and understanding of gold investments, perpetuated by the lack of experience in investing in gold.
But unpredictable left-tail risk events, coupled with heightened geopolitical risk means that asset diversification is ever more crucial for investors.
By providing a more illustrative and comprehensive guide to the facts behind gold investments, we believe that – given the challenging environment faced by insurers – incorporating gold as one of the alternative assets in an investment portfolio can further enhance portfolio diversification and provide insurers with an additional layer of protection.
