CFA Society New York hosted the 3rd Annual Insurance Company Chief Investment Officers Roundtable which featured distinguished financial and insurance professionals including keynote speaker Jeffrey Jacobs – Global Head of FIG Portfolio Management from BlackRock, moderator John Brown – Managing Director from Massachusetts Mutual Life Insurance Company, and panelists Bill Cody – CIO of Progressive, John Melvin – Head of Portfolio Management at Hartford Investment Management Company, Andre Keller – CIO of XL Catlin, Michael J. Pagano – Head of Insurance Portfolio Management from Voya Investment Management, and finally the closing keynote Bob Boyda, Head of Global Asset Allocation from John Hancock Asset Management. The event was also opened up by Deepika Sharma – Treasurer of CFA Society NY, then closed by Bridget McKenna – VP within Institutional Advisory Services at Nuveen.
Here are the highlights:
- Volatility in 2018 is a very normal and healthy form of market behavior. In a credit cycle that is rather rich like today, we can expect a greater level of volatility. We can expect 2018 to exhibit higher volatility than the outlier low year of 2017, and even more so in 2019 as the U.S. expansion matures. A downturn is certainly on the horizon, as it is a matter of when, and not if. Though a significant downturn is not expected this year. Like stock pull backs and corrections in an environment with strong fundamentals, any type of credit widening are viewed as buying opportunities. Volatility in rates on the longer end is expected to be kept in check despite Fed hikes as there still remains global buyers as yields across the world are still in negative territory.
- In baseball terms, we are past the 7th inning stretch in this economic expansion. Extra innings are certainly in the cards as we expect a longer duration in this cycle giving the depth of the financial crisis. Fundamentals are pointing to continued expansion as GDP is solid and small business which tend to benefit most from reduced taxes and deregulation are getting exactly what then need to invest, grow, and lift the economy. If you look at most economic indicators, such as the yield curve, manufacturing, inflation, capacity utilization, housing, autos, lending, etc, they continue to point towards rising global growth and that a recession is unlikely in the next couple of years.
- While inflation is grinding higher, we don’t expect runaway inflation. Up until recently when the Fed has arguably met their employment mandate, that first Friday of the month when the Bureau of Labor Statistics has released their Employment Situation report, the focus has been the job numbers. Now investors are turning their focus towards hourly wages which we saw have an uptick of greater magnitude on February 2, 2018 with wages at 2.9%, much higher than the past years 2-2.5%. We can expect future reports to be more focused in inflation than the employment picture. Ultimately, inflation will be the driving force for the Fed to become aggressive with their monetary policy.
- Ben Bernanke followed by Janet Yellen have been very focused on messaging. By the use of framing and careful selection of wording, the Fed has minimized volatility and seeks to avoid a second taper tantrum as realized in 2013. The old saying of “Don’t fight the Fed” is very alive, and very important when making investment decisions. The Fed has built up a $4.5T balance sheet through 3 rounds of quantitative easing. This unwinding is expected to increase volatility despite the process being rather glacial. The unwinding is a new dynamic which hasn’t happened before in history, so certainly you can expect surprises and higher volatility. Global central bank balance sheets have ballooned from $3T to $11T since the financial crisis. With the Fed exiting gradually, we can expect some volatility as discussed previously. But what happens when ECB and the BOJ start unwinding in addition to the Fed? The real fed funds rate is currently negative as the target range is 1.25-1.5% and inflation is around 2%. Looking back historically, real fed funds averages during recessions have fallen over the past 30-40 years. We can expect a lower real fed funds during next recession. While we are negative territory now, we could very well see a recession even if the real fed funds rate is in the 1-3% range.
- 2017 ended with a pickup in global growth which has surprised to the upside. This pickup is expected to help carry the US economic expansion making it the longest on record. When thinking about global growth, GDP is a proxy for earnings, and earnings are a proxy for stock prices. An uptick in global growth is bullish for stocks.
- We are in an artificially low yield environment as a result of extreme accommodative monetary policy across the globe. Flows around the world are chasing yield. Yet, with the concerns around US funding deficits, treasury issuance is expected to rise putting upward pressure on yields.
- Similar to risk assets such as stocks, fundamentals such as profit margins and leverage are favorable. Spreads have narrowed and bonds are rich. A gradual rise in yields are welcomed as maturing bonds can be reinvested in higher yielding securities. Within high yield, an additional level of credit research is warranted given the tight spreads and even higher valuations. Private credit is in high demand and there is a bubble in dry powder searching for deals leading to being extremely selective when allocating capital. With loans, like high yield, credit due diligence is key.
- CMBS securities have been interesting to watch during the recent volatility. They have not sold off like they during past periods of negative volatility which is a very important indicator of economic health. It will be interesting to see what happens to Autos, cards, and student loans during the next economic downturn.
- Relative to developed markets, valuations are very attractive despite the outsized returns in 2017. An overweight is warranted. Unlike the developed markets, the population growth remains conducive to outsized economic growth. In addition, productivity is growing at a faster rate and when paired with population growth, giving EM a higher growth rate. With the rise in oil prices, many exporters from emerging markets have benefitted. Though their remains concerns around commodities. We haven’t had a commodity shortage in almost 2 decades. Given the rise in global growth which drives commodity demand, a risk is the dwindling supply of copper or cobalt.
- Still underowned in the United States with Europe remaining the leader in implementation.
Management of Property & Casualty vs. Life Insurance portfolios
- The investment objective of a Life portfolio is focused on Asset Liability Management while P&C portfolios try to maximize return and protect the balance sheet. For Life portfolios, you can expect more leverage, more risk, and a key focus on LDI. The LDI asset allocation is predominately fixed income, with risk assets at the margin. P&C portfolios have a much shorter duration due to the nature of the liabilities. Considering valuations are rich and spreads are tighter, higher quality on the short side looks attractive. When things are overvalued, it is an opportune time to diversify away from concentration risks and sell overvalued investments. Many insurers are on the defensive side due to the macroeconomic backdrop. You can say that macro is generally the starting point of research, paired with rigorous bottom up research, and then blended with scenario analysis to determine key risks.
Rate hike ramifications for insurance portfolios?
- Rate hikes can be extremely attractive if you are viewing it from the perspective that your net investment income is going to increase due to rising rates. On the negative, unrealized losses will pick up. When considering liabilities, rising rates may impact the asset side, but the liability duration also falls, so should be a net economic wash. In a rising rate environment, as long as you hold till maturity, your valuations end up converging and maturing at par. Another risk to rising rates is credit widening, and potential defaults. Duration of the portfolio should gradually rise as rates rise, though duration positioning is mainly dependent on the liabilities. Duration is not typically where you want to take risk when managing an LDI portfolio. Duration neutral across the curve is prudent, and taking risk in credit is the strategic approach to adding value.