Good morning. I'm Mark Chen, Challenger's General Manager of Investor Relations. Welcome to Challenger's 2023 Half Year Results Briefing. We're coming to you today from our Martin Place head office in Sydney. Today's briefing will be conducted online. Today's presentation will be followed by a question and answer session. You can ask a question via the online portal or via the telephone. Today's presentation will be provided by our Chief Executive Officer, Nick Hamilton, and Chief Financial Officer, Alex Bell. I'll now pass on to Nick to get us underway.
Thank you, Mark, and good morning. Let me begin by acknowledging the Gadigal people of the Eora Nation, on whose traditional land we meet today, and pay my respects to their elders past, present, and emerging. I'm particularly pleased to be joined by our newly appointed Chief Financial Officer, Alex Bell, to deliver Challenger's first half results. Alex was formerly Challenger's Group Deputy CFO and has a deep intrinsic understanding of our business. Personally, I'm delighted to welcome Alex back to Challenger. Alex will take you through our financial results in more detail shortly. Alex's appointment now completes the renewal of our leadership team. Alex joins our talented and experienced group of executives who will take Challenger forward. Challenger starts 2023 in great shape, with a clear purpose of providing our customers with financial security for a better retirement.
Today's result highlights the diversified nature of our business. Challenger is performing strongly, benefiting from demographic trends, today's economic environment, and the efforts of our talented team. We're making very encouraging progress executing our strategy. We've delivered strong growth in our core retirement products. We have embedded a new customer growth model, centering a great business around a purpose we bring to life for our customers through our market-leading products. Today's presentation will cover the key drivers of our first half result, including record annuity sales. How we are generating significant long-term value from increased demand for income in retirement. How we're driving better outcomes for our customers to support future growth. Our priorities and outlook for the remainder of FY23. The advantages of Challenger's diversified business model are reflected in our performance across the half.
Group normalized net profit before tax, which reflects the underlying performance of our business, increased 5% to AUD 250 million. Statutory profit was lower due to investment markets, which in the half resulted in largely unrealized investment experience. Life earnings increased by 13% over the period, coming from an expansion in margins supported by higher sales and book growth. Higher demand for guaranteed retirement income delivered an 11% increase in life sales to AUD 5.5 billion. Significantly, we're seeing strong demand in the retail channel, with retail annuity sales up nearly 90%. In funds management, earnings have been impacted by lower FUM compared to last year. We've performed well in a difficult market environment, with group FUM otherwise stable in the first half 2023. Group ROE is up 20 basis points, driven by higher ROE from our life company.
Our capital position remains strong with significant financial flexibility. Challenger Life held AUD 1.6 billion of excess regulatory capital or 1.59 x the minimum required amount. Reflecting our confidence in the business, the board has determined a fully franked interim dividend of AUD 0.12 per share, in line with our target payout ratio of 45%-50%. This is a very pleasing interim result that demonstrates the strength of our business, the opportunity we have long term, and sets us up extremely well for the full year. There are a number of key dynamics that are influencing the standout performance in life in terms of customer demand and sales.
The chart on the right-hand side of this slide shows the material shift in the life sales mix towards the retail channel as our teams focus on capturing the growing demand for secure income from our retail customers. The macro environment has created some tailwinds for our business. Higher interest rates and the premium yield we can offer our customers has increased the attractiveness of our products. This is playing out alongside the broader trends of higher demand for income, particularly as people head to retirement. Challenger's annuity rates are back at levels not seen in a decade. High rates in our team's focus is also driving longer tenor sales and higher reinvestments, with 71% of new retail annuity sales if the term's greater than two years and on significantly higher volume as compared to 61% a year ago.
The higher volume is being driven by our retail channel across both our term and lifetime products. Pleasingly, lifetime sales themselves were up 70% on the prior period. Alex will provide more details on these trends later in the presentation. At its heart, Challenger is a purpose-led business focused on our customers to provide them with financial security for a better retirement. Our four strategic priorities describe how value is created at Challenger. As we described at our Investor Day, we do this by leveraging the combined capabilities of the group, whether that's our people, our balance sheet, our investment capabilities, or our partnerships. These capabilities enable us to expand the range of products and services we create and offer to our customers, which provides long-term growth and strengthens the resilience and sustainability of the business. Our capabilities are our true strategic advantages.
The strong relationships and trust we have nurtured among advisors over many years gives us an exceptional distribution footprint. We remain the most recognizable brand in retirement income, a role we will continue to invest in and nurture. Our asset origination platform across fixed income, real estate, and alternatives provides Challenger an engine that can support growth and is an area we will continue to invest into, as is evidenced by our strategy. New for many has been understanding our investment, our investment administration capability, which has supported growth in AUM to almost AUD 100 billion, and under the name Artega, provides a platform for future growth. Our dynamic, collaborative culture makes Challenger an exciting place to work, ensuring we're able to attract and retain the great talent that ultimately deliver the better outcomes for our customers and shareholders.
Our purpose, our strategy, and our capabilities define our future success. The rapid normalization of interest rates help. Our long-term performance will come from the unique core capabilities we have in our business. I would like to highlight the initiatives we are focused on to help us achieve our purpose. A key priority has been to align the business around our customers and improve the way we deliver our products. Being focused on our customers and being a long-term partner is a priority, which includes supporting super funds as they design retirement solutions for their members or the retail advice sector as they support millions of Australians achieve financial security. I've highlighted some of the key initiatives we're focused on this half to improve our customer experience. To make it easier for our customers to transact with us, we launched a new registry system in our funds management business.
This has also established a platform that supports the expansion of our suite of active ETF products, accessing a broader market opportunity in a format that customers are increasingly seeking. In our life business, we have commenced work that will significantly improve customer access to our guaranteed annuity products. By the end of this year, our customers will be able to buy a range of our term annuities simply and quickly online. We're supporting our customers who want more income at the start of retirement with the addition of a new accelerated payments option for our innovative market-linked annuity. You will recall the announcement we made at our Investor Day last year to establish a joint venture with global technology partner SimCorp, which we've now named Artega Investment Administration, a combination of our names.
It takes our existing capability and deep expertise in investment operations to build a new tech-led end-to-end investment administration service at scale. We've invested in the setup of Artega during the half, and this is reflected in our expense base, which Alex will talk to. Artega is operational, servicing its existing Fidante and Challenger clients, and has recently won its first external client. Core to Challenger's success has been our asset origination capability in our Challenger Investment Management platform. Working with Apollo, we have established the framework for our new non-bank lending joint venture. In the period, a highly experienced chair and CEO have been appointed, and the business has been in market and has developed a strong pipeline of opportunities.
Distribution is a core strength of Challenger, and with Apollo, we've collaborated on a range of product opportunities, including exciting plans to bring Apollo's aligned alternatives capability to Australian customers. Challenger has a strong track record developing successful strategic partnerships, which we've demonstrated over many years through our relationships with MS&AD group in Japan and our affiliates in Fidante. This includes, for MS&AD, a long-term annuity reinsurance relationship, which delivered us over AUD 400 million of longer duration sales this period, as well, the new property mandate awarded in FY 2022. Our decision to sell the bank allows us to focus on our core Life and funds management businesses. We announced the sale to Heartland in October, which remains subject to regulatory approvals. Excess capital of around AUD 100 million will be returned prior to completion, providing additional financial flexibility.
The initiatives I've outlined have a strong strategic focus. The execution of our strategy is progressing well. We will continue to take advantage of the broader macroeconomic conditions driving demand for our products. I will now pass to Alex, who will provide the details of the first half result.
Good morning, everyone. I'm delighted to be back at Challenger in the role of CFO, working with such a talented team towards our shared meaningful purpose. As you've heard from Nick, today's results reflect the progress we're making to simplify our core franchise, diversify revenue streams, and build a more customer-centric business. This is a terrific foundation for my first Challenger results briefing. Turning to the numbers in more detail. We have achieved a normalised net profit before tax of AUD 250 million for the half, an increase of 5% on last year. This was driven by strong life book growth and margin expansion, partially offset by lower funds management earnings and the investment in a number of growth initiatives. We remain on track to achieve our full year normalised net profit before tax guidance.
This half earnings represent 49% of the midpoint of our full year guidance range. Statutory net profit before tax was AUD 123 million, down 56% on last year due to fair value movements in the investment portfolio that are largely unrealized. Challenger's total income increased by 6%, reflecting growth in Life normalized cash operating earnings, offset by lower funds management fee income. Expenses increased by 7% or AUD 11 million, of which AUD 5 million or approximately half of the increase relates to the bank. Excluding the bank, expenses increased by 4%. Normalized net profit after tax was AUD 167 million, an increase of 1%. This is less than the increase in the pre-tax earnings due to a higher tax rate.
The tax rate increased to 33% with a one-off prior period adjustment, increasing the tax expense by AUD 5 million, which is equivalent to a 2% impact on the tax rate. Pre-tax return on equity was 12.3%, which was 20 basis points up on last year. Group Funds Under Management closed the half at AUD 99 billion, down 14% on prior comparable period, but stable on the half. Looking at the income and expense drivers. Income was AUD 411 million, an increase of AUD 24 million or 6%, driven by an increase in normalised cash operating earnings. This is partially offset by lower funds management fund-based fee income. Life income or normalised cash operating earnings increased by 10%. This benefited from both higher average investment assets and a 20 basis point expansion in the COE margin.
In funds management, net income decreased by 11% or $10 million, with average FUM down 14% on last year. Expenses were $158 million for the half, an increase of 7%. This was largely due to a higher number of Bank employees, investment in a range of growth initiatives, and some inflationary pressure. Excluding the Bank, expenses increased by 4%. The group cost to income ratio was 38.5%, and excluding the Bank, the cost -to- income ratio was 36.7%, a decrease of 40 basis points. We remain absolutely disciplined on expenses and confident of hitting our full year expense growth of 5%-6%. More recently, investors have been focused on the impact of rising inflation and interest rates on our business.
This chart highlights the positive impact of higher interest rates on Life's ROE. During the half, the RBA cash rate increased by over 200 basis points and Life's ROE increased by slightly less, 170 basis points to 14.8%. It takes time for the interest rate impacts to be fully reflected in Life's ROE, particularly in relation to our property portfolio, as not all our portfolio is directly leveraged to interest rates. In funds management, ROE decreased due to lower FM-based earnings. For the group in aggregate then, pre-tax ROE increased 60 basis points in the half to 12.3%. This compares to the group's target for the half of 14.3%.
In accordance with our outlook statement set at the start of the year, we do not expect to hit the target in FY23 due to the impact from the bank and the lower Funds Management average fund. Looking at the Life business performance in more detail. Challenger has been building more resilient sales by diversifying across a range of retail and institutional products and clients. Total Life sales were strong and increased by 11% to AUD 5.5 billion. We achieved record half-year annuity sales underpinned by strong retail sales. Retail annuity sales nearly doubled to AUD 2.1 billion for the half. These retail annuity sales volumes are benefiting from the higher interest rate environment and strong reinvestment rates. The higher interest rates are improving the customer proposition and attracting new advisors and customers.
Reinvestment rates are strong, with 68% of fixed term annuities reinvested into another Challenger term product. This compares with a reinvestment rate of 62% a year ago. As a result of disciplined pricing on institutional sales, this channel was 14% lower at AUD 2.9 billion, and this was dominated by reinvestments. Overall, the strong sales result translates into life book growth of 5.5% for the half year. Average investment assets increased by 2% on the prior comparative period, and the R and the COE margin expanded by 20 basis points. Expenses decreased by approximately AUD 1 million, with higher personnel costs from wage inflation offset by timing of marketing and technology costs. With the higher income and lower expenses, life EBIT was AUD 263 million, 13% above the first half of 2022.
Looking at the drivers of the expansion in Life's COE margin. This slide highlights the key movements in the half, with higher interest rates visibly benefiting the return on shareholder capital. The COE margin for the half was 2.76%, up 20 basis points on last year, and up 13 basis points on the second half of last year. The product cash margin increased by 2 basis points. The fixed income portfolio benefited from higher interest rates, which has been largely passed on to customers through higher annuity rates. It is important to note that interest expense also includes the cost of Challenger Capital Notes and subordinated debt. In September, you'll remember we raised AUD 400 million of new subordinated debt and subsequently repaid an equivalent amount in November.
The impact of carrying additional subordinated debt for two months and of raising the new instrument at a higher margin increased the interest cost by approximately 4 basis points. Normalized capital growth was 6 basis points lower, reflecting the allocation from equities to alternatives, which has a zero normalized capital growth assumption. I'm committed to providing the market with greater insight and transparency. Today, here is additional detail on the composition of our sales and the tenor of those sales. As previously mentioned, the life business experienced strong sales in the half and particular retail sales, which tend to be at a higher margin and a higher ROE. As Nick mentioned, 71% of new retail annuity sales were of durations of two years or greater, compared to 61% in the first half of last year.
Maturities reinvested also lengthened, with more than half of those reinvested for a duration of two years or greater. Lifetime annuity sales were AUD 375 million, up 70% on last year. The strong annuity sales growth was supported by approximately 68% of all retail term maturities being reinvested and 87% of all institutional term annuities being reinvested in the half. The benefit of longer duration sales is starting to emerge in the maturity rate. We continue to expect a full year maturity rate of 34%, with it moderating from 18% in the first half to 16% in the second. Pleasingly, the higher interest rate environment is providing us with the opportunity to re-mix our sales and pivot towards retail business. This chart shows net flows or book growth of approximately AUD 1 billion for the half across all channels.
The benefit of our strategy to diversify sales is clear. After years of record low interest rates, sales were dominated by shorter duration institutional term annuities. The higher interest rate environment and a supportive yield curve is accelerating sales and providing us the opportunity to remix the book towards retail business. For the half, retail annuities accounted for the large majority of total net flows. We continue to maintain a high quality investment portfolio to meet our liability obligations. There has been no change in our risk management approach, and we fully match the asset and liability portfolio. Fixed income represents 76% of Life's investment portfolio, up 1% in the half. Within the fixed income portfolio, investment grade continues to represent 78%, which is above our target of 75%.
In the half, we exited our low beta equity portfolio, reducing our exposure to equities by 3 percentage points to 1%. We increased our allocation to alternatives by 3 percentage points, now representing 9% of the investment portfolio at the end of December. Alternatives are less correlated to credit and liquid equity markets and provide a source of liquid capital that improves our financial flexibility. Investment experience represents the fair value movements in asset and liability valuations, as well as net new business strain. Overall, we have reported a pre-tax investment experience loss of AUD 61 million for the half. AUD 45 million of the loss was a result of our net new business strain, and the remaining AUD 16 million loss was from asset and liability valuation movements.
The asset valuation investment experience was driven by gains in the fixed income portfolio, offset by property, equities, and alternative valuation movements. Within fixed income, corporate credit spreads tightened, driving positive valuation gains, partly offset by the widening of securitized markets credit spreads. Consistent with our policy, we have provided AUD 36 million or 21 basis points for credit defaults across two names. It's Life's policy to provide for any security downgraded below B -, and both securities continue to pay their coupons in full. For property, the AUD 37 million investment experience loss largely reflects valuation movements lower than our normalized growth assumption, which is a long-term view of investment return. Equity and infrastructure recorded investment experience losses of AUD 21 million from lower investment markets.
The alternatives portfolio, which consists of predominantly absolute return funds, posted a loss of AUD 56 million, which after adjusting for distributions, was in line with relevant indices. Turning to Funds Management. Funds Management EBIT was down 32% to AUD 31 million for the half. The decrease in EBIT is due to lower average FUM, which was down 14% compared to the first half last year. The reduction in average FUM includes both the derecognition of Whitehelm Capital, which was about AUD 5 billion, and weaker investment markets in the second half. Pleasingly, FUM was stable across the half, with both closing and average FUM finishing at AUD 93 billion. Funds Management expenses increased by AUD 4 million due to investment in the platform, particularly our fixed income capability, deployment of new technology, and higher trading volumes.
The total net income margin increased by 0.7 basis points to 18.7 basis points, with the margin expansion attributed to a change in product mix following the sale of Whitehelm Capital and redemptions on a number of low margin fixed income mandates. Looking more closely at net flows. Funds Management net outflows were driven from fixed income managers and a number of institutional outflows in a domestic equity manager. Net flows and client distributions were fully offset by AUD 3 billion of positive market movements, with the S&P/ASX 200 increasing by 7% in the half. Investment performance remains strong, with 97% of FUM outperforming benchmarks over three years underpinning future inflows. With 17 affiliate managers and a diversified model focused on generating alpha, we are well positioned.
The chart on the right-hand side shows that we have outperformed our peers nine out of the last 10 quarters in terms of net flows. We continue to be strongly capitalized and maintain significant financial flexibility across the group. Life's PCA ratio finished the half at 1.59 x, which was stable on last year and well above both APRA's minimum requirement and our own internal capital targets. There is approximately AUD 100 million in excess capital in the bank, which will be returned to Challenger prior to sale completion. As Nick outlined, the sale of the bank is subject to regulatory approval. Challenger's financial strength was recently reaffirmed by S&P Global Ratings, who confirmed Challenger Life's A rating with a stable outlook.
Reflecting the strength of the business, the board determined a fully franked interim dividend of AUD 0.12 per share, which was in accordance with our payout ratio, 4% up on last year. In conclusion, we have delivered a result that shows the benefit of diversification. In Life, we're positioned to benefit from a more favorable economic environment, accelerating sales and margin expansion. In Funds Management, earnings reflect average FUM movements, particularly impacted by movements in the second half of last year rather than this half. We continue to invest for the future and believe our diversified model will outperform. I'll now hand back to Nick and look forward to rejoining you for Q&A.
Thank you, Alex. Turning now to the outlook. Today, we have reaffirmed our FY23 guidance. We continue to see full year normalised net profit before tax within the guidance range we set at the start of the year of between AUD 485 million and AUD 535 million. Today's result, reflecting 49% of the midpoint of this range, gives us a strong platform for the full year. Our Life business continues to benefit from the broader macro environment, with rising interest rates supporting sales and margin expansion. As noted, ROE is expected to be below the through-the-cycle ROE target this year due to the impact from the Bank and lower contribution from Funds Management. The speed at which the RBA has increased interest rates means it will also take time for the benefit to be fully reflected in our earnings.
We have reaffirmed our expense guidance, and as our result demonstrates, we remain very strongly capitalized within our 1.3-1.7 range. I'd like to conclude today's presentation by sharing our media priorities for the second half. We will maintain the momentum that we have achieved in the first half by capturing the strong customer demand for our guaranteed income products, with our team focusing on driving longer-term and lifetime sales; managing our balance sheet to take advantage of market opportunities; and maintaining our customer focus in Funds Management to meet demand when end markets improve. We will continue to improve customer experience by digitizing the annuity sales and reinvestment processes. This will allow customers to buy simple term annuity products quickly and easily, and also create efficiencies for our business.
We look forward to providing you with an update on this as we progress. We will leverage our expertise, capability, scale, and reach of our broad range of strategic partners to deliver more value to our customers and our business. We will remain disciplined on expenses, directing resources for growth initiatives and ensuring we support returns for our shareholders. Finally, we'll complete the sale of the bank and return AUD 100 million in capital to our balance sheet. I'm extremely pleased with the strong performance of the business in the half. We're delivering for our customers, leveraging our competitive advantages to meet more of their needs by providing financial security for a better retirement. We achieve this through our talented and committed team, and I would like to thank them for their energy and their dedication.
Alex and I will now take your questions, and I'll hand back to Mark. Thank you.
Thanks, Nick. We'll now turn to the question and answer session. As a matter of process, we'll first take questions over the telephone, and then we'll cut to the online portal. Operator, are there any questions via the telephone, please?
Thank you. Yes, i f you wish to ask a question, please press star one on your telephone and wait for your name to be announced. If you wish to cancel your request, please press star two. If you're on a speakerphone, please pick up the handset to ask your question. Your first question comes from Simon Fitzgerald from Jefferies. Please go ahead.
Hi there. Thank you for taking my questions. Just given the current interest rate environment, and the non-deductibility of the Capital Notes, just interested to know in terms of your optimal funding mix and what you're thinking about in the future.
Thank you for the question. What I might do is I'll ask Alex to make maybe a comment on some of the elements of the funding mix. I think as a broad statement, Simon, you know, we maintain a diverse source of funding on the balance sheet, and access, and accessing debt capital markets periodically is an important part of that program. Clearly, you know, what you've seen in this period is, you know, there is some higher interest expense costs to some of the tier paper that we have. Alex, you might like to add a comment to that.
Yeah, sure. Thank you, Nick. Thanks for the question, Simon. You know, as you know, we operate within the Prudential Standards, so we have access to a diversified capital base of issued share capital, as well as the Capital Notes and the subordinated debt, and that's a mix that we're comfortable with. As noted, we did refinance AUD 400 million of our subordinated debt last year, so we raised the new issue in September and called the old issue in November. That was at a slightly higher margin, but the non-deductibility of that interest is not a new feature. We're comfortable with the mix at this stage.
Yeah. Okay. Two more quick questions here. The two clients that were downgraded to CCC, can you confirm whether that was an external party that rated that, or was that downgrade related to your own internal rating systems?
Do you want to speak about policy?
Maybe just a reminder for everybody on the call. The Challenger Life policy from a valuation perspective is to anything that is rated below B-minus, we provide for on a default basis. The two that we've provided for today are, you know, dip below that at 31 December, we have provided for them in full. Neither of them are in default, and they do continue to pay their coupons in full.
Was that based, the downgrade to CCC, that based on your own internal rating systems, or was that an external party that rated those?
Yeah, they were externally rated.
Understood. Last question then. Nick, just I'm interested to know just on the longer term sort of outlook on the relationship with MS&AD. I mean, you know, the relationship expanded in 2019 with the U.S. dollar based annuity, and then there's a real estate investment management partnership, I believe, that was announced not long after that. I'm not quite sure how much FUM that has in it. Maybe you can give us an update on that because, you know, for a strategic relationship, not really that much has happened since the U.S. dollar denominated annuity. You know, looking at the agreement between the two parties is still for JPY 50 million. Just wanting to get a bit more information on that.
Yeah. Thanks, Simon. I mean, as a comment, the relationship is very, very strong. The agreement with MSP on reinsurance is for JPY 50 billion. What you've seen, you know, in this half is AUD 414, which is near to 80%, of that on a AUD translated basis. You know, that is a key feature of it. The expansion of that relationship last year to incorporate a real estate outsource management program using our Japan real estate team, I think is a strong signal as to the value. You know, we seek to add value to each other's businesses, where we can. There is a very strong, very healthy relationship with MS&AD and MSP, and we'll continue to explore ways to further that relationship.
Okay. Probably just thinking one more just in a bit more context around the $56 million in other gains on policy liabilities. Says it was related to inflation instruments. Just, if you can just provide a bit more color there or detail, please.
Can you just repeat the start of that question, Simon?
Just wanted a bit more detail, if we could please, on the AUD 56 million in other gains on policy liabilities. Says it was related to the inflation-linked instruments, but just wondering if we could get a bit more detail around that in terms of the valuation gain.
Yeah, sure. No, no problem. The investment experience in aggregate represents all the assets and liabilities being marked to market. What we've shown today is by asset class, the impact of those valuation movements. Within liabilities, you have both the impact of our net new business strain as well as the impact from the hedges.
All right. Thank you.
Thank you. Your next question comes from Kieren Chidgey from Jarden. Please go ahead.
Morning, guys. Couple of questions. Maybe just starting on the Life business. The spread margin there, sort of as you flagged, improved nicely over the half or on PCP 20 basis points. As you point out in your chart, sort of that's still come in the shareholder investment return bucket. The product margin has been fairly flat. Just wondering if you could sort of indicate why that's been the case. Is it a mix issue? Are there other factors sort of we should think about on a go-forward basis, around the product spread?
Yeah, sure. Thanks very much for the question, Kieren. As you said, really pleased with the aggregate COE life margin up to 2.76% for the half. Most of that uplift is coming from the shareholder funds, where we're really seeing the more immediate benefit from the increase in interest rates. In the product margin itself, that's up 2 basis points in the half. We have seen investment yield go up for interest rates and other abilities to drive greater yield. Most of that is passed on to our customers, which is part of the valuation proposition from an annuity perspective. The other thing I would point out, though, is that in that interest expense, as well as the cost of funds to annuities, we also include our subordinated debt.
That double-up of the two months of subordinated debt that we had in the half does create, a 3 basis point headwind to the margin in the half. We've also got a 1 basis point headwind from the fact that the new instrument is at that higher rate. Obviously, the double-up doesn't persist into the second half, but that higher rate will do.
Okay. Thanks. From a mix perspective, if we continue to see sort of more terming our greater growth in lifetime product, from a sales point of view, should we expect a sort of less mixed pressure or even potentially a positive mixed pressure going forward? How do you actually think about the margin differential from a mix perspective?
Well, I might, Kieren, just sort of start off. I think the comment is right. I mean, in the last three or four years where we've written very substantial amounts of shorter dated business, you know, that clearly it meets our ROE hurdle when we write the business, but it creates less COE earning signature, for want of a better word. You know, what we've, what we're seeing coming through in terms of the greater volume of longer-dated sales, you know, is definitely supportive. I think something we are, you know, happy to say today is that the business in aggregate that we're writing today is accretive to our COE margin based on our pricing and the asset yields that we're able to achieve in market.
Okay. Thanks, Nick. Just on the retail annuity sales, I think you touched on in your commentary the direct to consumer sort of strategy. Can you unpack a little bit more where you are sort of in terms of putting the IT platform in place for that, when you'd expect to potentially go live? Similarly on the institutional side, what product development and sort of traction you've seen over the past six months?
Thanks, Kieran. I'll start on that one. What we did through the first half, back in September last year, was we ran some campaigning in market to test our capacity to or ability to attract our customers that, you know, wouldn't have come down through the traditional advised source. We were pleased with what we saw there. Our business has traditionally been a B2B through platform business on the life side. What we are working on now is the way, is a means to take our term annuity product to simplify some of the features and to effectively digitize the customer onboarding experience. Similarly, you know, one thing that we're also you know, working on right now is reinvestments.
You know, we've seen in the retail side, our reinvestment rate has ticked up, which is really great. The number of, you know, clients that we have is clearly growing. Finding ways to improve the reinvestment experience for customers is really supportive of reinvestment rate in our view. We're trying to open up the front end and also improve the reinvestment process as well on retail. In terms of timing, what I said is, you know, we are looking to middle of this calendar year, so the back end of this financial year to have, you know, have some of the first releases of that available. In terms of institutional product development, you know, our business with institutional clients takes a number of streams today.
We've got our institutional annuity products, our institutional GIR or guaranteed index products, and we've seen some growth in the GIR. We've seen a little bit in the institutional term products. The team are very focused on discussions with institutions around ways we can improve on those products, if you like, product development around them. That might lead to some longer tenor. The team are focused on that. More broadly with the super funds, we, you know, we're engaged in a lot of discussions as we see this momentum building, you know, genuine momentum building around designing and developing retirement solutions for their members. There's, there's sort of multiple streams. One of the reasons why last year we put together and we increased the scale of the team that is focused on supporting that institutional channel in the institutional solutions team. Kieren, does that answer the question?
Yeah. No, that's great. Thank you very much.
Thank you. Your next question comes from Lafitani Sotiriou from MST. Please go ahead.
Good morning, everyone. A few questions from me, if I may. The first is in relation to the exit rate on the COE spread. Can you give us an idea as to where it roughly was sitting in December?
I might just start off on that, Laf. What we've called out is a NCOE margin here of 2.76%. The way that I've made the comment before, you know, that. That has increased half on half, but the business that we're writing today is accretive to that margin, but we don't provide, you know, really explicit guidance. I know you're asking about December, the comments there would be, we've traveled to 2.76%, but we're writing business today that is accretive to that in the book. You know, as you know, all other things being equal. Well, probably what I would say, a lot of things being equal, we see a pathway for that margin to go higher over the, you know, over the medium term.
I mean, clearly it's gonna go higher 'cause of the impact on the, or the regulatory capital supporting it. Are you saying that it, the new business you're writing is accretive excluding that impact?
That's correct.
Yeah, it's accretive excluding that impact. Okay. Can I just clarify or follow up on one of the questions I think Kieren asked around some of the asset allocation? Maybe just if you could remind me, 'cause historically, you know, when a Challenger was writing longer data than new issues, you would tend to move away from fixed income as an asset class. As in the last few quarters, your book has been extending, but you've actually increased your exposure to fixed income. Can you just talk a little bit more about that longer term trend that we should see in that asset class allocation? Then also more specifically, what you're seeing nearer term in the respective asset class pricing that may change how you're allocating in the short term.
Yeah, I might just provide a little bit of context and I'll ask Alex to provide some more. You know, over the last three or four years, the balance sheet has changed the asset allocation composition. Today, you know, we have a materially higher weight, you know, towards fixed income, of which we, you know, 76%, 78% of that being IG, and sub-IG being the balance. That's a very diversified portfolio. We have seen a growth or, you know, the new business we're writing pleasingly, we're seeing, you know, that tenor extend. You know, it is still, you know, there's still a lot of term business in the book that we, you know, that we're writing and, you know, fixed, the fixed income assets we originated are really good assets for those, you know, those liabilities.
Yeah, I think that's absolutely right. You know, we match our assets and our liabilities, which is that very first principle, the investment decisions that we take are all made on a relative value basis. You have, over the course of time, seen a slightly higher weighting to fixed income. That's at 76% now of the total portfolio, but it's very, very diversified. It's across 1,700 different securities. We use a number of other asset classes to ensure that we have that mix of duration, as well as maintaining flexibility and liquidity, which is what we've done in this half in terms of increasing our exposure to alternatives.
Can I be a bit more clear then? If the tenor continues to increase in the new business that you're writing, should we see fixed income stay at a steady level? Would you expect that to fall over the medium term?
Well, I think what we're saying today is that we're not seeing, we're not expecting any material changes in the asset allocation mix that we have today. We've called out the increase to alternatives, which is, you know, being funded from reducing the low beta equity position. Other than that, we're not calling any material changes today.
That's great. Thanks for clarifying. Just one last question. In funds management, you flagged higher investment. I'm sorry if I've missed this, but can you just give us a little bit more detail as to what the money or increased investment in funds management is going towards? Is it one-off in nature? Is it project based, or is this a resetting of the cost base?
Yes, sure, Laf. I'll take that question on expenses. You have seen this half, a weighting of our expenses more to the FM side of the business than the life side, and that's a matter of timing. The first, in the first half, we launched our new registry system Boardroom for the FM business. That's the most material investment that was made into that business. There are also higher transaction volumes. That affects the costs that we are allocated from our investment operations, which will be Artega from the 1st of January, because those are volume related. Some of the data feed costs that FM uses are denominated in U.S. dollars, and the exchange rate has gone against us a little in this half too.
There's a mixed bag, but a lot of them are one-off in nature to the first half, which is why we're really comfortable in reaffirming the 5%-6% growth for the full year today.
Okay, excellent. Thank you.
Thank you. Your next question comes from Nigel Pittaway from Citi. Please go ahead.
Good morning, Nick and Alex. Just first of all, I was hoping to return to the product cash margin and the comments you made about needing to pass on interest rate rises to customers. I was just wanting to try to get your feel of the sort of nature of that competitive pressure and whether or not you feel that competitive pressure will intensify as, you know, as people expect, deposit pricing to get more competitive?
Nigel, I might start on that one. Thanks for the question. You know, I think, you know, Challenger's product range on the life side operates across quite a broad spread. You know, where we've got that short dated or shorter tenor term business, say one year, you're definitely seeing rising competitive pressures around that. And that's coming from, you know, the big four banks and NEOS, et cetera. You know, I guess our response to that would be we still look competitive on a relative rate perspective, but we're gonna maintain our pricing discipline. And that probably speaks a little bit to the term annuity within the institutional channel where, you know, we'll write business at certain levels, not at other levels.
What pleasingly we're seeing is the stronger growth out out the tenor where that competitive pressure eases materially, plus also the features of the product start to really kick in. You know, the term annuity products has features that advisors use that are different to a term a term deposit product. Then also clearly with the lifetime product and the care products, that's a different proposition again. I think, you know, the comment there around, you know, the competitive pressure, you know, our response has been, you know, to really try to push the efforts across the term. You are seeing good, strong reinvestment rates at the shorter end as well, and we've been prioritizing the retail shorter end business where we can, you know, practice a bit more price discipline, for want of a better word, relative to the institutional. Alex, I might just.
Yeah, no, that's all good.
And.
Thanks.
Nigel, did that go there for the question?
Yeah. No, that's good. Thank you. Thank you for that. Maybe then I could ask another one which is actually on the increasing tenor. I mean, obviously the good news of that is it should sort of, as you mentioned, slow maturities moving forward. I was wondering whether it also presumably dampens growth sales because, you know, you're not getting the same reinvestment rate. Can you make some comments on that? Do you expect it to dampen growth sales as you increase that tenor?
Yeah. It's not our base expectation. I mean, we are not. You know, whilst we may be, you know, a significant player in certain of the annuity categories, we're not within the term product, clearly. I think if I talk about term for a second, I think you're seeing a couple of macro dynamics as well, which is, you know, when in a zero rate or 20 basis point world, money just doesn't sit in term. It sits in cash or it goes out to risk. I think that puts the term products in a really good spot over a number of years to see, I think you are seeing this in the statistics, money coming back into that segment, you know, as a whole.
To the point about impact on future sales, you know, the market opportunity for us feels bigger than that which we are taking, you know, right now. We've got supportive demographics. We've got annuity rates at a level which we haven't seen in a decade. We've got a sales engine which we've maintained through the harder years, you know, for sales, and we're really energizing that part of the business and it's responding extremely well. I think there's a number of dynamics that, you know, feel good as we look forward that.
Probably the final comment, Nigel, would be that a reinvestment in and of itself, a shorter dated piece of business reinvested, you know, there's a cost to that as well, to manage from an organizational perspective. Plus also where we match the assets to liabilities, it reduces the investment opportunities for us alongside those liabilities. You know, I don't think that. For us, that's definitely not a negative we're thinking about.
Okay. Thanks for that. Maybe just finally, I wanted to ask about sort of asset values. I mean, obviously the adjustment in terms of property values was relatively modest this period, but I mean, as sort of interest rates have risen and we look out to the future, how, A, are you feeling about your property values and, B, also about your fixed income default risk and how you might weather any potential downturn in that space?
Thanks, Nigel. I think I'll start with property and I'll ask Alex to pick some of it up as well. I think we run, we've always run a portfolio here that we see as a defensive very pleasingly. In the half, we saw the leasing rate actually increase across the portfolio. You know, the office assets are largely tenanted or majority tenanted by government or government agencies. And we have our retail assets which are anchored by non-discretionary food and other retail and essential services. The assets themselves are performing really well, and they line up really neatly alongside the really long-term liabilities, you know, that we have.
Real estate's a strategic asset class for us. You'll note that, you know, the allocation to it, at 14% as it's come down, over time. You know, we're very, you know, but we feel very good about, those assets. Before we get to fixed income, I might just ask Alex if she wants to.
I suppose just a couple of reminders. We are really pleased with how our property portfolio is performing and it is a very diversified and defensive portfolio in that regard. From a valuation perspective, which is sort of directly to your question, we externally value 100% of our properties every year, and we split those into 50% at each of the two halves. At this half we've had 51% externally valued, and we use the marks from those external valuations in making sure our internal valuations on the other 50% are reasonable. There's no doubt that lower volumes of sales in the property space does mean that there probably is some pressure on valuations as we look into the next half.
We're really pleased with how our portfolio is performing, and as Nick said, more than 50% of the rent we receive on our office portfolios is from government tenants, which is really sticky. 58% of all leases have an expiry after FY 2027. That's another data point there.
Coming to credit, I mean, Alex has made a few comments about the diversified nature of the portfolio. I mean, credit investing is very much core to what Challenger does and the credit underwriting, you know, program that we have. We've noted, you know, the allowance we've made in the period for some specific names that have gone below to B -. You know, I would actually look at it maybe from the other side where, you know, this environment and the normalization of credit spreads and the pricing of risk, you know, gives us a great opportunity to be active across the markets in the asset portfolio. That's not trying to wash any of the risks and, you know.
It's a team that has managed through cycles, you know, clearly over many years. The team today feel quite, you know, pleased, excited about the opportunities that are developing within, you know, within the markets.
I think that's right. Maybe just one thing to add, just when we think about that fixed income portfolio. The 35 basis point normalized assumption that we have is very much a long-term one. Although, the defaults that we've written in this half represent 21 basis points, so 42 annualized, that normalized assumption that we had, we have outperformed in the long term. We're not concerned.
Okay, great. Thanks very much.
Thanks, Matthew.
Thank you. Your next question comes from Matt Dunger from Bank of America Securities. Please go ahead.
Yeah, thank you very much, Nick and Alex. Just wondering if I could ask on the ROE target. You've called out the rising bar, 14.3%. You know, current cash rates imply over 15.5%, ROE pre-tax target in FY 2024. Do you think this is achievable? What's the timeframe for achieving your ROE target, given the move in interest rates?
Matt, I'll make a couple comments to that. Well, we think the target is achievable, and we, you know, we've noted in the past that it's a through the cycle target. You've seen a real, a very sharp move higher in rates. We're seeing the benefit of that, you know, flow through the life ROE, which we noted at 14.8% at the end of the year. Clearly not all the assets there. It's not a linear transmission of higher rate through to COE. There's been some, you know, in this period, some quite specific drags that through time, you know, start to unwind that are weighing on it. I might ask Alex to make a comment about that.
Yeah, sure. Thanks Matt for the question on ROE. Just in thinking about when we set that target, it was done before we held the bank. There's a double dynamic from the bank. We've got the fact that it's loss-making in its own right, as well as some excess capital sitting in there. There's about 50 basis points of a drag coming from that part of the business. The other component that is new is the lower contribution coming from the FM business. We see that as a through the cycle lower contribution. That's why we feel comfortable with the ROE target. Really pleasingly, I think if you look at the life, standard life, Life Company standalone, what you've seen is the increase in ROE at 170 basis points over the half in comparison to the 200 basis points movement in the RBA cash rate.
There is a bit of a lag, and it does take some time to fully come through, but it's certainly directionally moving in the right, in the right direction.
It's probably one other comment around the ROE. It's And we I made the comment earlier. It's how we think about the business as well. It's how we think about pricing, the annuities, so the new business that we're writing. It's how, as a group, we think about, strategic investment decisions that we make. We're absolutely committed to it. Hopefully now it's just comments there. You can see, you know, the pathway, through time to it, meeting its target.
Great. Thank you very much. Just to follow up, if I could on the cost growth. Alex talked earlier to 4% cost growth, excluding the bank. This implies there's a bit of a step up in the second half cost growth to get to that 5%-6% guidance. Can you confirm where that's coming from? Is that funds management, as you mentioned earlier?
I'm happy to take that one directly, Nick. Just to clarify, the 5%-6% cost growth that we have outlined for the full year, that does include the bank, 'cause when it was set, we included the bank in that guidance. The bank is certainly a driver of some of the overrun in the first half, but so is the FM business. That registry investment into technology, and we see that focusing more on the Life business in the second half of the year. I think the other thing to call out is that we've not been completely immune to inflationary pressures. There's some wage inflation which we've kept reasonably contained, but it's clearly not zero.
In comparison to last year, you know, the business activity, you know, very pleasingly, is higher than it was before. Sales teams back out on the road and a bit more travel. That's all baked in, though, to that 5%-6% increase.
Great. Thank you very much.
Thank you. Your next question comes from James Cordukes from Credit Suisse. Please go ahead.
Good morning. Look, you're annualizing double-digit annuity book growth, which is nice to see again. At the same time, that's kind of also driving some new business strain, which is probably running at a, you know, I call it AUD 100 million a year now. In the quarter, you helped fund some of that growth just by allocating to less capital-intensive assets. If you do sustain that level of growth, what levers have you got to actually fund it from a capital perspective?
Yeah, Matt, thank you. Note slightly less capital intensive in the period. The business that we've been writing and the level of capital we have today, we feel in a strong position. I take the point that we're creating new business strain. You know, we are pushing term and tenor out. We're doing that through the term business, and it is the 234 where the capital intensity that, you know, to back the assets, to back the liabilities there isn't creating, as you can see in the result, an impact on our capital position. We're able to, you know, through a combination of factors, sustain that. You know, I think what we'd say is we feel really well capitalized, for the growth that we can see in front of us.
I think that's right. Maybe just a couple of things to add, Nick. You know, that range is really important to us from a PCA perspective, the 1.3-1.7. We're comfortable to, you know, operate anywhere within that range as long as the investments and sales are meeting our ROE target. At 1.6, there's plenty of wiggle room there. Plus, as noted, we do have the AUD 100 million of excess capital sitting in the bank, which will be returned to the group upon the sale. That will give us an extra boost of capital there too.
All right, thank you.
Thank you. Your next question comes from Siddharth Parameswaran from JP Morgan. Please go ahead.
Thanks. I had a follow-up question on that point around capital. I suppose it's a similar issue just around where you'd sit versus your targets 1.3-1.7. You know, in a rising interest rate environment, do you have any bias as to where you'd like to sit within that? I mean, I know you say that you're comfortable, Nick, but I mean, just, you know, higher interest rates, are you happy to run that down if you sustain this level of growth?
I think I'd be careful of the language here. We feel very, very well capitalized. I think if you look back on the year that's been, we've achieved very strong book growth in a market environment that has been very volatile, whether that be, you know, rates, spreads, equity markets, currencies. You've seen over the last 12 months the capital move around. So we're always very careful to say we use the range, because it will through time, you know, through time change. There are levers that we have, you know, clearly in our investment program that change the capital intensity, which are available to us. Yeah, I think, Sid, we talk about a range. Clearly, the bottom end of that range is designed for market extremists.
You know, we're not talking here about running capital down to that level through the ordinary course of business. You know, we're operating towards, you know, right towards that upper end of the capital range. We feel like we've got a lot of, you know, flexibility. You know, probably maybe final comment is that with the, you know, with the switch into the absolute return strategies, you know, one of the benefits of that is as a liquid source of capital where, you know, those assets are uncorrelated to credit or lowly correlated to credit and equities, which provides, you know, better portfolio diversification through, you know, through cycles. You know, there's a number of things that we think about when looking at the capital. I just make sure, just look at Alex and see if there's anything you want to add?
No, it's all good. Thanks.
Yep. Okay. Thank you for that clarity. One other question that I have just around ROEs by, just for different types of annuities. Previously you'd said that the retail annuities and the insta annuities had similar ROEs. I was just, I mean, at the moment, you've painted a picture where rising interest rate environments definitely helped the attractiveness of retail annuities. You've also said that you've, you know, become more cautious in your pricing of institutional annuities. Just are they still similar in terms of ROE?
Yeah, I might just talk a little bit about the pricing dynamic because that goes to the answer. Yeah. Clearly, in the last 14 months, you know, with the sharp move in the swap curve, you know, the curve has done a lot of work. And I'm here thinking about the retail side around the shorter term product in terms of taking us out of very low rates into higher rates. Now we offer a premium to that, as you're aware, our cost of funds. What you've seen in this last 12 months, 14 months, is that that in the retail side has been lower than it has been, say, the year before.
It is, you know, on that base of pricing, we're able to, we've been able to grow that retail term business, at a lower cost of funds than, you know, institutional for the term, institutional term annuity products. You know, where those investors are sophisticated, and have a number of, whether it be asset allocation decisions they're making or other alternative investment options in a way, and ways that they can deploy their capital. That goes to, you know, similar products where the capital intensity is very equivalent, but we're getting slightly differential pricing.
Sorry, just where we sit today, because I understand definitely I can see in your, in some of the charts you provide on pricing annuities, there definitely was a gap that or a narrowing of the gap with, o n the retail side, just now, you know, as we sit in February.
I was just going to say, I think, Sid, that both statements were true at the points in time that they were said. They're really at extremely low interest rates. It was fair to say that the ROE on retail and investment and in institutional business was very similar. As we start to have that yield curve, we are able to create a bit of distinction such that we are seeing better ROE and better margins on the retail business. It's not enormous. You know, careful not to overplay that.
Yeah. We have increased the cough on some of the shorter end of the retail business relative to what it was, say, eight months ago, nine months ago, if you look at the rate sheets.
Okay. Thank you.
Thank you. Your next question comes from Anthony Hoo from CLSA. Please go ahead.
Good morning, guys. Thanks. Just the first question, just on your CIM business. The fee margin declined, quite substantially, half and half down 4 basis points. Just wondering if you can talk through the drivers of that. You know, was there anything specific behind that, and is that a new base going forward?
I might pick that up. We might have to just come back and absolutely clarify. I think, you know, one of the dynamics in the CIM business, Challenger Investment Management, it's our fixed income and real estate business, is the major client for the real estate business is Challenger Life Company. A majority client for the fixed income business is Challenger Life Company. There is a larger third-party business in the Challenger Investment Management fixed income. What I'm going to reserve rights to be wrong on suggest is that it's probably through an increase of CLC monies being run relative to third party in the book, which is attracting a lower fee for the Challenger Investment Management business.
We'll come back to on that, Anthony. I think it potentially could also be driven by the timing of some of the property that was sold during the year. Bunbury in this half and County Court in the prior half, so you've actually got the base coming down. That will have reduced the fee margin.
Okay. Thank you. Just the second one. Looking at your Index Plus sales during the half, you had AUD 1.9 billion in sales. Looked like 75% of that was reinvestment of maturities, and the rest was inflows from existing clients. Does that mean that there were no new clients during the half? Then, you know, also wondering what your sense is for, you know, any insights you can give on, you know, the cadence of new client sales for the Index Plus product.
The reinvestment rate for Index Plus was 84% for the half. We did see some new flows. I mean, there is a good pipeline of discussions there, and there was a new client in that period. The Index Plus, just to, you know, remind you that, you know, it's replicating market indices, and it's a beta replacement strategy where the institution will give up liquidity in, you know, for term for a term premium. We feel good about that. They're clearly institutions. For us, that's very short-dated term business. We're trying to work with institutions around ways we can lengthen the tenor of the Index Plus product to their benefit and also, you know, to our benefit as well.
Okay. Thank you.
Thank you. Your next question comes from Andrei Stadnik from MS. Please go ahead.
Good morning. I wanted to ask two questions, firstly just around the benefit from the rate rises that already happened, 'cause you've alluded a couple of times it takes, you know, a little bit of time for that to flow through. Just assuming cash rates were the way they were on December, you know, how much more benefit would there be to the COE margin or renewal fee?
Yeah, I'm happy to take that one directly. Thanks for the question, Andrei. You're absolutely right. We are starting to see the benefit of rate rises come through that COE margin. It does take time, though. What we've called out today is that the business that we're writing from an exit margin perspective is accretive to that margin. The extent to which we continue to see rate rises, we will start to see the benefit of that coming through. As you've seen, when you look at the life company, there's a bit of a delay to that. There's some seasoning that will take time. And maybe just a reminder about that sub debt cost that will continue to be a drag into the second half with the new instrument being at a higher margin. That sits in the, in the interest expense, bucket.
Can I ask you for like a follow-up on that? Because, for example, the banks will provide us with details on the, you know, duration they replicate in portfolios and Challenger effectively that has been similar. Is there like a two or three duration shareholder funds?
We don't think of it in terms of specifically shareholder funds, but we do provide some information in terms of the duration on our fixed income portfolio more broadly. Across the whole of our fixed income portfolio, that's got an average duration of about three years. I suppose you could make that statement as all things being equal, over the course of three years, you would start to see the full benefit from any RBA cash rate increase.
Thank you. My second question, just like a high level question on, you know, the shift in the strategy towards, you know, the less, less volatile, you know, private credit setup, you know, we've seen with the Apollo joint venture. You know, how long do you think it will take to meaningfully, you know, reduce the earnings volatility or the capital intensity of Challenger?
I mean, we operate within the Prudential Capital Standards, Every asset that we own has a capital, you know, charge against it. You know, we manage the business prudently, and something that's very important to us is ensuring that the balance sheet is able to, you know, travel the journey through cycle because it's important to our franchise. I think what you can reflect on in the last number of years in terms of the shifting asset allocation moves that have seen the portfolio have less market volatility are meted, you know, to do that. You know, I'm not sure I can add.
No, I think that's right. I don't think we're explicitly calling anything out today that would suggest that we're meaningfully aiming to reduce the capital intensity of the Challenger balance sheet.
I think that's right. I mean, what we've said is there's no expectation. We're not calling out any material changes to our asset allocation.
Thank you.
Thank you. There are no further questions from the phone participants at this time.
Thank you, operator. There are no questions online. That closes today's briefing. Both Irene and myself are available on the telephones today should any of you have any questions to ask. Thanks for your interest in Challenger and have a great day. Thank you.