MetLife Eyes Hedge Fund Cuts After Poor Quarter

 A top MetLife (MET) - Get Report executive on Thursday said the insurance giant expects to significantly reduce its investments in hedge funds - following similar moves by other insurers and a big pension fund -- after it reported a lower than expected profit for the first quarter of 2016 partly driven by negative returns from investments in that asset class. 

"I think if look at the market environment that exists today and you can talk about a number of factors I think it will continue to be challenging for hedge funds and if you combine that with our capital and cash flow predictability objectives we've decided we're going to continue reducing our hedge fund portfolio," MetLife Chief Investment Officer Steve Goulart told analysts.

The move comes after MetLife reported earnings on Wednesday of $1.20 a share, down 17% from the same period a year ago and significantly lower than the consensus estimate calculated by FactSet for MetLife's quarterly earnings per share of $1.38 a share. It reported operating earnings of $1.3 billion, down 19% from the first quarter of 2015.

A key difficulty for MetLife was poor returns in hedge fund investments, which made up part of its so-called variable investment income. This category of investment earned $165 million, compared to $371 million in the first quarter of 2015 and the drop was "mostly due to weak hedge fund performance."

Goulart acknowledged that the first quarter was challenging for the firm's hedge fund investments, which were negative for the quarter. The hedge fund portfolio represents over $1.8 billion in investments and MetLife plans to reduce it by $1.2 billion, with about 60% of the cuts taking place in 2016 and the rest expected to be reduced most likely in 2017. In addition, MetLife redeemed about $600 million in hedge fund investments last year. "What we'll be left with is a small portfolio of our most consistently performing managers in hedge funds so there will be a small portfolio left over and overall it doesn't need to be the size today," Goulart said.

The reduction in hedge fund investments come as some large public pension funds including the California Public Employees' Retirement System, or CalSTRS, as well as a few other large insurers, including American International Group (AIG) - Get Report , have moved to reduce their investments in the alternative asset class after experiencing poor returns in the investment strategy.

Goulart noted, however, that MetLife's private equity investments "continue to perform fairly well" and while they returned slightly below the company's internal expectations they still were "very positive."

A so-called "unfavorable catastrophe experience," essentially property & casualty claims from large loss events, like hurricanes, tornados, hail storms, also factored into MetLife's lower results, decreasing its operating earnings by $45 million or 4 cents a share after tax.

In addition, MetLife CEO Steven Kandarian on Thursday told analysts that the mega-insurer still plans to continue to pursue a separation of a large segment of its U.S. retail business even though a federal court judge last month ordered regulators to remove the institution's "systemically important" designation.

"One of the questions we hear more than others is whether we still plan to pursue our separation of a substantial portion of US retail business," said Kandarian on a call with analysts. "The answer is yes. The [separation] decision was driven by both strategic and regulatory factors."

MetLife is in the midst of a major divestiture effort and a related battle with the U.S. government over its regulatory burden. The insurer and over 40 other financial institutions were designated by a council of regulators as "Systemically Important Financial Institutions" or SIFIs, a categorization that that comes with a costly and time consuming form of government oversight including tough capital and liquidity rules.

However, MetLife strongly disagreed with the designation, which was made by the Financial Stability Oversight Council, a panel of regulators charged with identifying future threats to the economy. It succeeded in convincing a federal court judge last month to order regulators to remove its SIFI status, though the Justice Department appealed the decision.

In a parallel effort MetLife announced in January that it was planning to spin off and sell a large part of its U.S. retail business, a move that it made as part of a separate effort to reduce its size and complexity in hopes regulators would choose to remove the SIFI designation that way.

On Thursday, Kandarian argued that the separation still had a broader strategic objective that includes a move to increase MetLife's free cash flow business as the soon to be separated retail businesses tend to generate lower free cash flow.

"Strategically the imperative of cash generation is stronger than ever, especially in light of the lower interest rate environment," he said. "And from a regulatory perspective while we are pleased that our SIFI status was rescinded, FSOC could re-designate us at a later date."

A part of that divestiture effort involves MetLife's agreement in February to sell its insurance agent unit known as Premier Client Group to MassMutual Financial Group in a $300 million deal. Once that business is sold off, the remaining unit still to be separated is expected to represent roughly 20% of MetLife's overall business, and the assets of the divested unit will be made up of U.S. annuities and life insurance operations sold to individual policyholders.

Kandarian did not provide much detail about whether MetLife would conduct an IPO or spin off for the U.S. business designated to be separated. However, he said that MetLife will likely be making an S-1 filing of IPO documents with the Securities and Exchange Commission in the summer "to prepare for the possibility of a public offering."

In addition to its vast international operation, MetLife will retain its entire group insurance business as well as about half of its U.S. annuities and life insurance operations and its institutional products operation.