At a glance
- Return on capital, or ROC, divides a security's spread by its capital requirement, standardizing comparison when several opportunities look fundamentally attractive.
- For a general account deciding where to commit capacity, return on capital moves the capital charge to the center of the decision.
- The regulatory capital charge deserves as much scrutiny as the spread because it is set by rule, not by the market, so an ROC ranking is only as durable as the charge behind it.
Insurers should rank competing securities by the spread each produces per unit of required regulatory capital rather than by headline spread, according to an essay published Nov. 9 by Insurance AUM Journal.
Return on capital, or ROC, divides a security's spread by its capital requirement, standardizing comparison when several opportunities look fundamentally attractive. Banks and insurers must hold required capital against positions, so their optimal holding for a given security can differ materially from that of a pension, endowment or total-return investor.
For a general account deciding where to commit capacity, return on capital moves the capital charge to the center of the decision. Two securities that look equally attractive on credit can carry different charges, and dividing spread by the charge can change which one ranks first. The charge itself becomes a number to confirm alongside the coupon.
The regulatory capital charge deserves as much scrutiny as the spread because it is set by rule, not by the market, so an ROC ranking is only as durable as the charge behind it. For long-dated assets, a charge that changes after purchase changes the return the account thought it had locked in. Fundamental credit work, the essay says, still has to accompany the ranking rather than replace it.
Reported by the Insurance regulation desk from Insurance AUM Journal. Published . Corrections