Guest Q&A with Rip Reeves
IAUM: You’ve been managing money for insurance companies for quite some time. And, you’ve had the unique experience of being on both sides of the market; the third-party asset management side and inside of an insurance company as the chief investment officer. How would you compare the two?
REEVES: The biggest difference for me when I made the switch from managing third party assets to being the chief investment officer, is convincing myself that it was okay, and I wasn’t falling down on the job by not knowing every single position, every single size, every single detail of all positions in every portfolio. Because as a portfolio manager, that’s what I’m paid to do. I’m paid to make those decisions and ensure they’re executed the way the team has decided to position them. So, I knew everything about every portfolio I was responsible for.
As the chief investment officer, I have hired third-party managers to do that for us. My job is not to necessarily know every single position. My job is to develop the most suitable strategy for our enterprise at any given point in time, execute it efficiently, and monitor it effectively.
It was quite challenging to “step back,” and I felt like I was ignoring the granular details of the portfolio I had spent 20 years focused on. That was the biggest challenge for me – to alter my primary focus to the ‘big picture’ instead of the granular details of every portfolio position.
IAUM: Markets are coming off a huge equity year, and yields are very low. In regards to risks in the capital markets, what’s keeping you up at night? What do you think are the biggest risks facing insurer portfolios today?
REEVES: I think most of us in the investment community are worrywarts by nature, so a lot of things may keep me up at night! For insurers, a lot has been written about the double-edged sword, which is price softness on the underwriting side of the enterprise and low yields/lower equity returns/higher risk premia on the investment side. It is a bit of a double pill to swallow from a business management perspective, and it seems to be an ongoing scenario for the insurance sector.
As someone who used to be a trader and a portfolio manager, fundamentals are what we can actually get our hands on as far as economic health is concerned – the tangible fundamentals which occasionally seem less relevant with continued globalization of economies. This information challenge certainly makes international issues a higher priority than they were in forming an opinion of US economic health than 10 years ago. When you have over 40% of revenues from S&P 500 companies generated outside the US, what’s going on internationally is more impactful, regarding economic and credit analysis.
Technology is certainly making an impact as well, given the speed with which events are made public….as in immediately. Global events we didn’t hear about for days or weeks 10-15 years ago are now on the Bloomberg news tape like equity prices. And the quantity of information is impressive as well, so there’s a plethora of “news” items we are bombarded with given globalization and technological advances.
Probably the biggest issue I tend to worry about is the unexpected. There are geopolitical issues that generally seem to come at us from nowhere that are impactful to the investment markets, which is one reason the risk premia has increased, and we have lower return forecasts for equity assets, 2019 performance aside.
It’s the things you and I don’t have control over that weigh on me when developing our investment strategy, given the challenge to incorporate these various issues into our strategy – if possible. When a government, any government, decides to do something surprising, or when there’s an international issue – like the coronavirus – these issues generally hit us broadside, and you need to be nimble enough to handle them as they come…because they will come.
IAUM: Speaking of international markets, this morning the UST 10-year note is 1.57%. There are five industrialized nations that are trading at negative interest rates – one of them being Greece. In 2012, the highest yield for Greek debt was in the high 40% range and now it is at 93 basis points – substantially through the US, right? So, while people talk about rates being low in the US, globally, they’re not.
REEVES: That’s correct about US rates for the global investor and what a bummer we didn’t buy Greek bonds, right?
IAUM: Because the US trade is high yield versus a lot of sovereign debt, when you look at performance of the investment portfolio, are you looking more at yield, or from more of a total return perspective? And, what about constraints? You’ve managed this money – both sides – so you know the impact of constraint. What are your objectives or how do you measure performance for the asset managers that are out there?
REEVES: It’s interesting you pointed out that US rates are historically low, which they are, and may be going lower?? However, relative to other bond options the global investor has, US rates are pretty attractive. This observation should have a couple tailwinds for our domestic market. First is that the current attractiveness of US rates should keep a ‘bid’ for our bond markets. Second is that this relationship should also be a net positive for the USD as well. Given we have a Lloyd’s Syndicate, we are a global insurer and therefore a global investor. We are required to invest in several currencies to support our non-USD liabilities. Regulatory required non-USD investments can have a significant impact on our investment performance, given our reporting currency is the USD. Currency risk generally takes up a large allocation of our risk budget, given its historical standard deviation of returns. When previously managing global portfolios, we could be dead accurate on analyzing the fundamentals of the country decision, but the currency part of the investment could dominate the net performance of trades into foreign positions due to currency volatility. Hence, we’re very focused on managing our FX exposures in our investment portfolio and at the enterprise level.
Additionally, the US yield curve is relatively flat historically. So shortening our investment portfolio’s duration – and reducing risk – is not as much of a yield give up as it usually is. We are able to keep portfolio yield relatively consistent, while reducing duration risk, which seems like a good trade in our current rate environment.
IAUM: Has the rate environment impacted your overall product offerings at all, from the standpoint of what you’re offering and the pricing?
REEVES: Not really, that’s more a function of the focused business mission that AEGIS has as an underwriter.
IAUM: We’ve talked about rates being low, that the US is still a decent opportunity versus global alternatives. A lot of insurers have been walking out the risk curve. That’s been going on for quite some time. I think it has not been one big leap – it’s been a slow migration, right? At first it was high yield and EMD out bank loans were – you know – now we’re giving liquidity. At the end of the day, how much have you moved into what’s known as “risk assets” to make up for the lack of investment income? Or have you?
REEVES: We have not. We’ve actually gone the reverse and reduced risk in our portfolio strategy over the past couple of years. One of the luxuries I have at AEGIS is that our primary investment objective is optimizing after-tax total return within a predetermined risk budget. Therefore, yield or gain/loss objectives are secondary regarding the formulation of our investment strategy. Therefore, if a particular strategy happens to be a yield give trade for example, it’s likely not a deal killer should the return expectations be more attractive. This flexibility is a little unusual in the insurance space. Given our opinion of the current risk/reward trade off of investable assets, we’ve decided to take some profits and reduce equity risk and the duration risk of our investment strategy.
The efficient frontier curve, regardless of whose forecasts you use, is relatively flat. This observation is a function of very low rates, lower equity forecasts, and higher standard deviation of returns of our global asset choices. When risk assets have forecasted returns in the mid/high single digits, and interest rates are not projected to fall, the efficient frontier curve is generally unattractive. Looking at a flat curve, like we currently have, suggests it’s not an attractive market to stick your neck out further on the risk curve….the opposite is more prudent. These models are just tools in our strategy process, but they’re an objective tool, and it’s rather difficult to argue with the numbers. Thus, we’ve been reducing risk in the current environment and keeping some dry gunpowder for when investment opportunities appear more attractive.
Within our equity allocations, we’ve traded into low volatility and high dividend strategies to help limit downside risk, while knowing we’re giving up some upside potential. A market like we experienced in 2019 is certainly a bit of an opportunity cost, given the outsized-returns we experienced last year. On the fixed income side, we scaled back the duration of our high yield allocation by half. Additionally, we increased the minimum credit quality to B3/B- with limited exposure below. These two decisions still maintain a relatively high income level for the allocation, while reducing the downside risk, should bond markets experience a flight to quality.
Bottom line is, we are not particularly confident in the current market’s risk/return trade off, so we’ve scaled back risk in our riskier investment allocations while still maintaining commitments to the markets.
IAUM: Okay, then what about private markets? More specifically, what is your allocation to private assets? And how do you see private markets developing versus public markets?
REEVES: The short answer to your question is we have increased our investments to the private/alternative sector over the past six years to approximately a 20% targeted allocation. We have executed this increase in a steady, methodical progression, and these mandates provide our investment strategy with a solid base return that is effectively agnostic to fluctuations in interest rates and equity markets (barring a credit event).
As a portfolio strategist, there are several “trades” we can make to increase income and potential return. First, we can trade duration by going out to curve (and increasing duration). I don’t think at historically low rates, most folks would think it’s an opportune time to extend portfolio duration – plus the yield curve is flat as well. So, we’ve shortened in this environment.
Second, you can go down in credit quality. I believe most of my CIO peers have likely pushed down in credit as much as they believe is prudent, given this trade was popular a decade ago. So, you’re probably not going to get further improvement in the return forecast from this trade.
Third, you can look at increasing leverage via several options. Securities lending isn’t as attractive as in the past, given our low rate environment. I would caution the use of investment leverage in other mandates, given it would take a large allocation(s) to notably alter your return forecast, and we’ve experienced how dangerous large amounts of leverage can be in your investment strategy…so use wisely and sparingly.
The last thing we have in our portfolio we can trade for increased yield and potential return is liquidity. Given most insurance portfolios have large allocations to high quality bonds, we generally have good liquidity. When you measure levels of stressed investment liquidity relative to the necessary liquidity required to service your book of business, we observe that we have excess liquidity. We began formalizing our liquidity analysis and monitoring when I joined AEGIS nine years ago, and have become pretty obsessive about our liquidity position. This focus is in part due to our increased investment in the private sectors where we currently have allocations in direct corporate lending, commercial MBS, infrastructure, MLP bonds, private placements, and real estate equity. We have a very diversified approach to this sector, consistent with our approach in the public markets. So far, so good.
IAUM: Do you have any passive investments?
REEVES: Yes, we have passive investments. If you look through our portfolios, we’re barbelled in passive versus active, and there are a couple of reasons for that. Obviously, fee is one of them, although it’s not the driver of this strategy decision. The primary reason to use passive investments is our belief that a manager cannot consistently add alpha in a particular market. This opinion is generally that the market in question is an efficient one. Towards the end of my portfolio management career, outperformance targets began to decrease for high-quality mandates, given market efficiencies. This observation has simply spread to more asset classes over the past 10-15 years….and should continue. The US Treasury market, Agency market, Agency MBS, and short/medium duration high grade corporates are particularly efficient markets that we approach with a passive investment strategy. We’re going to approach them in a passive manner, get index pricing and market exposure…while still altering the guidelines to fit our risk profile. Even though you’re using a passive strategy, you can structure portfolio guidelines to suit your specific risk/return profile. These mandates are generally the “liability” portion of our investment portfolio, and it provides us room in our risk budget to potentially increase allocations to riskier mandates. Where we believe managers can add value, such as in privates, below investment grade and equities, we have active mandates and fee schedules. Our below investment grade mandate is one of our active strategies, where we allow guideline flexibility to buy any part of the capital structure of an approved credit as long as it fits within the duration and credit quality guidelines we have in place. This investment strategy allows positions in traditional high yield, bank loans, convertible bonds, preferreds, and structured products. There’s some tactical capability in this opportunistic, short duration high yield mandate. We’re happy to pay for active management where we believe managers can consistently add alpha.
IAUM: How do you think technology will affect the management of insurer portfolios and – more broadly – institutional asset management?
REEVES: I fully expect it will continue to be a tailwind for increased efficiencies of any and everything we’re doing from portfolio management to banking to asset allocation. That’s kind of a general – non-tech expert – answer to your question!
IAUM: So, this is our last question and typically our readers’ favorite.
IAUM: Some of our listeners and readers are just starting out in their careers. What advice would you give your 21 year-old self?
REEVES: It’s interesting that you asked this question Stewart, because on Monday I have a new team member starting who’s 24, and we’ve had this exact conversation during his interviewing process…he listened very politely to my long-winded answer which is likely why he got the job! Like me, this guy put himself through college and graduate school and is interested in a career in investments – but knows nobody in the investment world. Therefore, he has had little help with his career – until now. When I first came to Wall Street from Harahan, Louisiana, I didn’t know anybody either. So, I tell young folks just starting out to focus on a few things to help themselves.
First, find a good firm with a good name, and just get in the door. Don’t be too picky regarding your job title, necessarily, but just get the best starting job you can at a solid firm. Some great starting positions at firms like a BlackRock, a Goldman or a Pimco are for example, an RFP (request for proposal) writer or investment accounting. These are ‘unsexy’ jobs to many of the MBA graduates from fancy schools, therefore the competition for these positions are not what they are for investment banking. What these jobs offer you is an opportunity to learn a wealth of information about the firm – you’ll learn a valuable skill, and you’ll have a front row seat to the whole company. Most importantly, you’ll be able to pay for yourself! It’s a very valuable way to get some experience and knowledge, so the next move you make will be a more educated one.
Another thing I’d tell myself is to find someone – or some group – that will commit to you. I got very lucky on the Salomon Brothers trading floor right out of the gate. I had three partners of the firm take me out to Harry’s Bar on Wall Street and literally said, “We’re going to teach you everything we know if you come work for us.” It wasn’t necessarily the hot area on the trading floor, but I had three partners of the firm committed to me, and they did exactly what they said they would. I couldn’t have asked for better mentors, especially right out of college.
The last thing I’ll mention is try to be as honest with what you like and what you don’t like. I think I’m pretty honest about what I am and what I’m not. Bottom line is, this industry pays well, so there’s lots of folks wanting to enter it. When you’re talking about your career, the more true you are to what you really like and what you don’t like, you’ll have a better shot at enjoying it for your whole career. Being idealistic, that likely means you’re a happier individual, a better teammate at work, a better spouse, a better father and so on. You’ll be a better whatever it is you are! That’s kind of important, given that you’re talking about your career. My kids, at 23, 24 and 25 don’t have perspective of that. You and I do, because we’re on the back half of our careers. I’m thrilled with most of my career choices, given that I was honest with myself during many of the decisions over the years. Some of my choices weren’t necessarily the most financially attractive ones, but they were better for me. Ok, I’ll get off my soapbox….I can see my kids rolling their eyes about now!