Divide what the fund earns by the capital the insurer must hold against it. The ranking it produces is often the reverse of the ranking by return, which is the whole reason insurers compute it.
Return on Solvency II capital is a fund's expected income divided by the standard-formula capital the insurer must hold against it. On four illustrative 150 million mandates, a private credit fund returning 8.90 per cent on an 18.90 per cent charge earns 47.09 per cent on capital, while private equity, with the highest return at 11.50 per cent, earns 23.47 on its 49 per cent charge. Ranked by return and ranked by return on capital, the four funds share no position.
Worked in full in Insurance Capital for Asset Managers by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
An asset manager pitching to an insurer usually leads with return. The insurer's investment committee reads the same proposal as income per euro of capital, and the capital comes from a table in the Delegated Regulation, not from the manager's risk model.
Four candidate funds, 150 million each, expected returns net of the manager's fees. Charges are standalone standard-formula charges, before diversification, with the equity symmetric adjustment at zero. Every figure is illustrative.
| Fund | Charge basis | Expected return | Charge |
|---|---|---|---|
| Listed equity fund | Type 1 equity, 39% + SA | 7.20% | 39.00% |
| Private equity fund | Type 2 equity, 49% + SA | 11.50% | 49.00% |
| Direct real estate fund | Property, 25% | 6.80% | 25.00% |
| Private credit fund | Spread risk, BB, duration 4.2 | 8.90% | 18.90% |
The credit charge assumes the insurer receives a look-through inventory: BB loans with a duration of 4.2 years take 4.50 per cent per year of duration, 18.90 per cent. The derivation is in the Solvency II spread risk charge on a bond. Without look-through the whole fund would be charged as type 2 equity at 49 per cent, unless it is a closed-ended, unleveraged alternative investment fund established or marketed in the EU, which the Delegated Regulation treats as type 1 equity at 39 per cent.
Income = size × expected return
Capital = size × standard-formula charge
Return on capital = income ÷ capital = expected return ÷ charge
The size cancels, so the ratio is simply return over charge. In Excel: =C5/E5, and =RANK(G5,$G$5:$G$8) beside it to see the order.
| Fund | Income | Capital | Return on capital | Rank by return | Rank by ROC |
|---|---|---|---|---|---|
| Listed equity fund | 10.80 | 58.50 | 18.46% | 3 | 4 |
| Private equity fund | 17.25 | 73.50 | 23.47% | 1 | 3 |
| Direct real estate fund | 10.20 | 37.50 | 27.20% | 4 | 2 |
| Private credit fund | 13.35 | 28.35 | 47.09% | 2 | 1 |
| All four | 51.60 | 197.85 | 26.08% |
The order inverts. The real estate fund, last on return, is second on capital: against private equity it gives up 4.70 points of return, 7.05 million a year, and saves 24.00 points of charge, 36.00 million of capital. The credit fund earns far more on capital than anything else, 47.09 per cent against 27.20 for the next, because its charge is less than half of private equity's.
Put differently, the 28.35 million of capital the credit fund consumes would support only 57.86 million of the private equity fund, earning 6.65 million, against 13.35 million from the credit fund. For an insurer whose capital is the binding constraint, that is the comparison that matters.
A ratio favours whatever needs least capital. If capital is not binding, a second reading helps: return less a charge on capital. At an illustrative 6 per cent, the cost-of-capital rate long used for the Solvency II risk margin, the excess is 8.56 per cent for private equity, 7.77 for credit, 5.30 for real estate and 4.86 for listed equity. Private equity comes back to the top. Which reading applies depends on whether the insurer is short of capital or of return.
| Symmetric adjustment | Listed equity charge | Listed ROC | Private equity charge | Private equity ROC |
|---|---|---|---|---|
| −10 points | 29.00% | 24.83% | 39.00% | 29.49% |
| 0 | 39.00% | 18.46% | 49.00% | 23.47% |
| +10 points | 49.00% | 14.69% | 59.00% | 19.49% |
Even at the most favourable adjustment, private equity's 29.49 per cent stays below the credit fund's 47.09. The mechanics of the adjustment are in how the symmetric adjustment changes the equity charge.
Fees work the other way: they cut income and leave capital untouched. One further point of fee on the credit fund costs 1.50 million a year and takes its return on capital from 47.09 to 41.80 per cent, a cut of 5.29 points, 11.24 per cent of the figure. The lower the charge, the more each point of fee costs on this measure.
Divide return by charge: 47.09 per cent for the credit fund, 27.20 for real estate, 23.47 for private equity and 18.46 for listed equity, an order that shares no position with the return table. Insurance Capital for Asset Managers explains why the same fund costs two insurers different amounts and which levers the manager controls, and the free workbook for this case charges and ranks the four candidates side by side.
Because Solvency II capital is scarce and each asset consumes a different amount. On four illustrative 150 million funds, private equity has the highest return, 11.50 per cent, but a 49 per cent charge, so it earns 23.47 per cent on capital; a private credit fund returning 8.90 per cent on an 18.90 per cent charge earns 47.09, twice as much per euro of capital.
Under the standard formula, unlisted private equity is type 2 equity: 49 per cent plus the symmetric adjustment (a closed-ended, unleveraged EU fund is type 1, at 39), which moves within plus or minus 10 points. At an adjustment of zero, a 150 million fund needs 73.50 million of capital; at plus 10 points the charge is 59 per cent and the fund's return on capital falls from 23.47 to 19.49 per cent.
Every point of fee comes straight off income while the capital charge stays the same. On an illustrative 150 million private credit fund with an 18.90 per cent charge, one more point of fee costs 1.50 million a year and cuts the return on capital from 47.09 to 41.80 per cent, 5.29 points, because the income is divided by only 28.35 million of capital.
This article is one calculation from Insurance Capital for Asset Managers. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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