David Worsfold
In setting the scene in his opening keynote presentation – Of Trumps, tiaras and tantrums – to the recent Insurance Investment Exchange seminar on 7 March, Bob Swarup, principal at Camdor Global Advisors, highlighted the “disconnect between the business pages and the front pages” as he sought explanations for the comparatively low volatility since the middle of last year.
He set out a scenario where the current supply of investable assets has been shrinking as a result of quantitative easing and share buybacks just as demand has been growing. With low liquidity and a mismatch of supply and demand, conventional wisdom says volatility should be high, said Swarup.
But it hasn’t.
“If volatility is low in these conditions, it says that most people are sitting facing the same direction”, said Swarup. The increasing geo-political turmoil – with Brexit and the election of Donald Trump principal amongst recent events – have created very short term spikes in volatility but these have quickly settled down, suggesting that they have been driven more by the sentiment of the front pages rather than the economic and financial logic of the business pages, which remains focused on somehow muddling through despite growing warning signs. The danger is with such apparently strong consensus in the market that when volatility does make its anticipated return, insurers will find themselves with little choice and limited flexibility.
The challenge of picking out the threats and opportunities for insurance companies amid the growing political and economic uncertainty was thrown to the first panel which tackled the theme of ‘The Calendar of Uncertainty’.
The panel picked out some of the obvious challenges ahead if populism continued its forward march with elections due in Holland, France, Germany and probably Italy this year and Article 50 due to be enacted before the end of March. It also cautioned the audience to look out for the unexpected, highlighting the recent changes to the Ogden tables when the government suddenly lowered the discount rate for lump sum settlements from 2.5% to -0.75%.
For 2017, some of the biggest uncertainties surround the US economy which, the panel warned, could be in danger of overheating. This could lead the Federal Reserve to raise interest rates even faster than most commentators are predicting, with the strong dollar and any move towards dollar repatriation providing further tightening, tipping the world into recession, especially, as Swarup reminded the audience, “The Fed is the world’s central bank. For emerging markets, it is the only central bank that matters”.
The fear that we may be at the start of a secular bond market weighed heavily with several panel members and questioners, summed up by one: “We have all grown up with fixed income being the bedrock of portfolios – low but stable yields and low risk. That has changed, especially the risk”. Concern about the growing uncertainty in the bond market was among the top concerns of the insurance investors attending the event, according to their responses to the audience voting results.
When it comes to risk, there was unanimity that politics is now critically important because it creates binary events like Brexit, which are driving insurers and asset managers to adopt passive strategies to avoid downside risk. This could go too far. People need defensive strategies with a good number of defensive positions, but they also need to balance that with active management.
Another major topic which the panel highlighted as another certainty with as yet uncertain consequences was the rapid development of artificial intelligence. Most of the current attention has been on the range of current jobs and businesses that could be threatened by AI. It might be harder to think what jobs might be created by AI but this could be an important source of investment opportunities, especially if it tackles the low productivity growth that has blighted the UK and some other developed economies since the turn of the century.
The second panel that concluded the morning’s deliberations was themed ‘Crossy Road: Finding a way past the headlights” and, as the title says was charged with looking to the future.
It quickly picked up the concern raised by the first panel that passive management could become the norm, warning that sitting back was not good enough. It was important that portfolios are regularly stress-tested for resilience to the various geo-political scenarios that could emerge over the next four to five years. Into this mix should be thrown the question of what happens when QE unwinds as well as the threat of inflation.
As this discussion developed, the spotlight swung round to governance and the decision-making culture in insurance companies. Too many institutions are hidebound by a quarterly cycle of meetings and are missing opportunities. They have lost the ability to make quick decisions, putting tightly-defined strategies above tactical manoeuvrability. Internal and external managers need good policy, risk appetite and target return guidelines so they make decisions within days, if not within hours. This means allowing delegated authority along the value chain so long as the risk scenarios are thoroughly and regularly reviewed.
This would help insurers maintain a proper balance between active and passive management, essential if they are going to avoid markets where assets have become commoditised. This happens much faster now and quick thinking governance is essential if portfolios are to avoid becoming dominated by commoditised assets and get caught in the headlights of onrushing world events.
Few would disagree with these sentiments, though it remains an open question as to how many will move past debate to action.
The next Insurance Investment Exchange seminar will be on 13 June. To register now, click here