Do the Fundamental Things Apply? with Wellington’s Tim Antonelli

Stewart: Welcome to another edition of Insurance AUM Journal Podcast. My name is Stewart Foley and I’m your host, standing with you at the corner of insurance and asset management with a good friend of ours, Tim Antonelli of Wellington. Welcome, Tim.

Tim: Stewart, thanks for having me. Great to be on.

Stewart: We are happy to have you. Everybody’s been talking about COVID-19 forever and a day, and then now it’s like what do we do going forward, right? So insurers have been taking on liquidity risk for quite some time, and then March happened. What was the impact of March and the market fall on all those insurers that have had all this liquidity risk?

Tim: Yeah, that’s a terrific observation. So I think it’s been no secret that not only shares of the U.S., but the most pronounced global trend over the last five to 10 years has been the flooding of investments into illiquid asset classes. Now, whether you define that as private credit and private equity, which certainly continue to make up a meaningful piece or direct mortgages, commercial mortgage loans, et cetera, this now makes up a considerable portion of an average insurer’s invested assets. So if you think about life insurers for instance, it might make up something like 35% of their total invested assets.

Tim: That is an enormous amount of liquidity give. And to your point, when we saw the volatility spike in the middle of March, but liquid parts of their portfolio suddenly became less liquid. And so you had a lot of insurers scrambling to either find external funding sources, which we can talk about in a little bit or in some cases has to take realized losses on positions that they had traditionally thought of as very liquid. Simply put, as I like to say, you have liquidity in your portfolio until you don’t.

Stewart: Yeah. I mean, it’s so true, right. So it seems as though there was a case of the haves and the have nots. The folks that had already… The folks that were running the risk tolerance meter wide open and those that had dialed it back as we were coming into the new year. Did you see a difference there in insurer performance and how they did?

Tim: Yeah, that’s absolutely something we noticed. I mean, if you think about heading into this year, very few individuals had pandemic on their radar for concerns for their 2020 investment portfolio. What they did have were concerned about a looming recession, which oh by the way, still hasn’t gone away even in the midst of the volatility that we’re living in today. So in those cases many insurers, particularly those in the life and health industries had taken their foot off the gas when they were thinking about allocating to traditional market risk. Now, what that allowed those insurers to do were when they saw asset prices bottom again in late March where you saw investment grade spreads almost take 400 on an OAS basis, in high-yield spreads go over a 1000 at points, you saw these insurers being able to allocate on a tactical basis to take advantage of the market dislocation. But of course that assumes that you’ve built the governance structure that allows you to do that.

Stewart: That’s exactly what I was going to say, because when I was managing money a hundred years ago, it always seemed like the ability to take advantage of market dislocations sometimes got hung up and by the time it got through the investment committee or whatever it was, the market opportunity was gone, right. So you’ve got to be nimble in here, right?

Tim: Yeah. And I mean, I’d tell you the circumstances from 1920 when you were managing money to today are actually quite similar unfortunately. What you really see are ideas come to the various investment committees or boards, but oftentimes they’re proposed when the economics are attractive. And then by the time they work through the various committees and have board level approval, the value can be gone in the market. I think that’s changing. I think the most progressive insurance company investors have started to attack this in a couple of different ways. I think first and foremost, having a broader investment policy statement that doesn’t confine you strictly speaking in terms of hard caps on things like rating tranch or hard caps on things like the type of equities you might be considering.

Tim: Embedding that type of flexibility in your broad IPS allows for these tactical changes to be put in place without requiring everybody in the company being able to sign off on it. The other element that I think plays a very important part in this, which we’ve seen a huge demand for on a year to day basis, is that the idea of a strategic asset allocation being a once or twice every decade type endeavor even over the last year has changed substantially. So we’re seeing demand for strategic asset allocation refreshes on an annual basis at least. And I don’t think it’s a stretch to say as markets evolve and circumstances change as much as they do, to people even considering looking at a twice a year refresh in some respects. And that could increase the ability to get these one off ideas in the portfolio in a faster way.

Stewart: Yeah, it’s interesting you say that, because as you know investment teams spend a lot of time on strategic asset allocation. They work with firms like Wellington and they put their heads together and they’d come up with a strategic asset allocation for the coming year. And then I just picture in my mind a whole bunch of CIOs in their offices around right when March hit, just take that whole stack of papers and just wad it up and throw it right in the recycling bin, because March changed the game entirely. So what steps do these guys take now?

Tim: Yeah, so I think innovation and opportunity can come out of crisis. I’m a firm believer in that, you can ask any of my colleagues. And I think the insurance industry has shown an ability to be creative since the dawn of the industry itself. So I think there’s some lower hanging fruit and then there’s some things to consider from a more complex perspective. I think first and foremost you have to work your fixed income harder. It’s a theme that we’re incredibly used to, given that interest rates have been low as long as they have and it show no signs of increasing. But thinking about a new type of credit mandate, something maybe that straddles the triple B, double B, single B arena that reflects not only the increasing opportunity set that’s available at the triple B rating tranch level, but also allows your portfolio manager to look into fallen angels or things that you expect the balance sheet to improve over time.

Tim: And you believe the rating agencies are not fairly reflecting their true longer term risk in the current rating. I think that type of mandate is going to get a lot of traction. We’ve seen interest in the U.S. certainly, but also from non U.S. investors as the dollars cheapen. And I also think being able to get creative on your alternative side. So just because something has a prohibited capital charge doesn’t mean that the economic value add doesn’t make sense, right. So thinking about uncorrelated assets to the rest of your book, thinking about opportunistic investment styles where you’re giving the portfolio manager flexibility to go anywhere, and finally even considering revisiting the use of derivatives in your portfolio. I think you’d agree that derivative use plans and approvals and board level approval internally can be challenging for some insurers to want to begin the process to start. But I think these times where the markets swing around like they do could provide some compelling reasons why revisiting that might make sense.

Stewart: Yeah, it’s interesting. It seems like derivatives get a bad rap regardless and there’s a lot of things, right. It’s not the instrument, it’s how do you use it?

Tim: Yeah, exactly. And I guess even on that point about what the reputation of certain investments would be? I’m actually wondering if it’s not crazy to think longer term this idea that you have fixed income be your bread and butter, because it’s relatively lower volatility and in the past you’re investing into a rising rate market. If the interest rates circumstance doesn’t change meaningfully, maybe equity starts to take on a more significant share in how insurers are investing. And I think as part of that and the need to get something better than investment grade credit return streams, you do start to incorporate some financial risk mitigation derivative overlay. And maybe that asset class starts to evolve both in how it’s implemented by the insurer, but also how they’re thinking about it from a strategic perspective.

Stewart: Well, it’s interesting you say that, because I mean the capital charge on triple B corporates for example, it is what it is, but the attractiveness of that changes whether it’s a 2% or 5%, that’s not the same equation, right. So we’ve talked about this throughout this podcast and just having a good look at what is your strategic asset allocation, what’s your mindset and how does governance fit into that?

Tim: Yeah, challenging assumption.

Stewart: Yeah, exactly. And I think that’s the trick. So COVID-19 had a lot of impact on a lot of us on a personal level, right. I suspect that you’re not traveling quite as much as you were at one point. At least every single person that I speak with ever is not traveling, right. What have you been doing with yourself?

Tim: Yeah, so it’s a very stark contrast from my 2019 where I began the year recovering from knee surgery. Literally not able to walk. As soon as I could walk, it basically started a world tour where I had multiple trips to APAC, multiple trips to AMIA, a trip to central America. If there was an insurer in the world that we could speak to, I wanted to be speaking with them. So fast forward to this year, it’s been a little bit different to say the absolute least. I think what I’ve found is it’s a great time to start recapturing some of the hobbies that maybe you used to be more interested in. So for me, cooking is something I really enjoy, which now was a necessity, so it’s a good hobby to have. I started to really get back into playing the guitar again, I’m not sure if my neighbors are as excited about that as I am. And I even ended up building a saltwater reef tank in my apartment, because I’m a huge ocean and diving nut, so bringing the Caribbean to me on a much smaller scale.

Tim: And then, because not everything can be leisure, I’ve started studying for the sustainability and climate risk designation. Data is an extension of the financial risk management designation from the Global Association of Risk Professionals. And it’s been the affirmation of a lot of things that were very well aware of it, the firm given the focus that we have on studying the impact of climate specifically with Woods Hole. But it’s been a really good way to get a more global view at the different issues that result as not having a universal taxonomy for things like green finance and the lending side of that equation and the investing side of that equation. And certainly I like to remind insurers, this is something that needs to be top of mind for you right now, maybe more than ever. And the pandemic highlighted that when you think about the growth in pandemics from the lack of global biodiversity.

Stewart: So Tim, we’ve interview prominent CIOs and the theme that I keep hearing over and over again is ESG. You just mentioned climate related research that you guys are doing. Can you give us a glimpse into where you are now in that realm and where you’re going?

Tim: Yeah, absolutely. And actually this comes full circle from one of your earlier comments in the podcast today. So again, no secret insurers have piled into illiquid assets with very little ability to trade out of those. In fact, many of those are real assets, so the exposure to physical risks of climate change is huge. And so what we’ve started to do is using the model research that we’ve done with Woods Hole, as we’ve been able to start to build a physical risk climate footprint for insurance companies. And the goal here is twofold. Number one, insurers care about how they’re exposed, but they have no idea on how to quantify that exposure. So you can’t determine where you’re going if you don’t know where you already are. So we first try to think of a point in time, okay, here are the main physical risks you’re exposed to, here are the timelines in the past that are the worst outcomes for your enterprise, but then you start to think about that from the going forward perspective.

Tim: So, number one, if I’m going to increase my private asset allocation, maybe I start to think about diversifying or increasing the return hurdle that I’m going to need to make something like that make economic sense for me or number two, maybe I start to use public assets in a different way. So I like to call it a climate completion portfolio concept, where you use public market assets to diversify some of your risk footprint moving forward. Now, admittedly we’re still in early days here, but it’s incredibly interesting to me, because very rarely are you able to support something with so much research that the financial market simply haven’t priced in any meaningful way. Transition risk, we’ve seen price adjustments for high carbon. I think you’ve seen a lot of funds that invest specifically with that in mind, but we have not seen the same price move on the physical risk side. So it’s been really interesting stuff.

Stewart: It is interesting stuff. And it’s absolutely at the forefront and it’s no surprise that Wellington’s leading the way here. So can you recap as we wind down here, I like to ask my guest this. And I teach college students and some of them are getting ready to graduate and go out into the world. And you were there, you were in that seat. What would you tell your 21 year old self coming out of college?

Tim: Yeah, I would tell my 21 year old self don’t be surprised that you’re going to have a career working with insurance, because I don’t know if I would have believed that as a 21 year old self, but it actually makes a lot of sense. And I think the key for me was combining something that always challenges your intellectual curiosity with something where there isn’t a lot of precedent to do what you do. So the most enjoyable part of my job is to think about client problems and try to think of solutions that haven’t been contemplated before. And it doesn’t always mean that they get implemented. And it doesn’t always mean that every idea you have is going to stick, but you’re doing something where you’re not following a set blueprint on how to get there.

Tim: And truthfully, I think that’s what makes insurance asset management one of the more interesting areas of finance in general, because everything is a puzzle. So I would say have an open mind, work really hard, maybe don’t take two gym classes your senior spring semester and enjoy the time while you can. I mean, the college kids today, it’s such a unique circumstance for them and they’re going to miss out on some of those opportunities. So when you do have opportunities, you’ve got to make sure you take them.

Stewart: That’s great advice, really great advice. So I’m going to attempt to wrap up here and to recap. And you tell me where I’ve missed it. What I’ve got in my notes is first, reassess your business and look at it from all the different angles. Is that a good first step?

Tim: Yes. Challenge your existing assumptions, just because you said, “Oh, we won’t invest in an asset class because of a capital charge”. Maybe that made sense in a normal investment environment, but maybe it’s time to challenge that.

Stewart: Second point, take on investment risk measured in an informed way. And I think this goes back to what you just said. You’ve got to challenge the way in which you view investment risk. Is that accurate as well?

Tim: Yes. Using a playbook from as recent as the 2019 fiscal year simply won’t work right now. So add risk when you can, take advantage of market dislocation, but do so with a mindset on what the downside could be.

Stewart: And the the final point, try to be able to take advantage of opportunities as this market provides them and have a corporate governance structure and investment governance structure that allows enough flexibility to capture those opportunities while they still exist.

Tim: Yes. Use opportunistic investment styles, use PMs that have flexibility across asset classes, create investment policy statement that is as broad as it’s prudent, and also do diligence on investment ideas that might not make sense today, but could make sense in the future. Because then you’ll have the ability to allocate on a very quick basis to capture alpha.

Stewart: That’s a very interesting thought and way to look at it. I mean, it’s always interesting to talk to you guys. I mean, Wellington’s been in this space and managing insurance assets from, I don’t know, the number that I have in my notes is 1975. I worked for another firm that started way back in the day. That is when you were pioneering third-party asset management. And today you guys are running 130 billion or something like that of insurance GA asset. And my experience in working with Wellington is that you always have really good thought leadership. And I mean, this podcast has been no exception. And I want to really thank you for being on.

Tim: Stewart, thank you for having me and look forward to connecting again soon.

Stewart: So this is Tim Antonelli, Multi-Asset… Give me your… Is it Multi-Asset Strategist in the insurance channel, what’s the right titling there?

Tim: Yeah, so it’s Multi-Asset Insurance Strategist and yeah, it’s a very broad mandate, but at the end of the day, the singular focus is partnering with our insurance clients to help deliver strong returns.

Stewart: That’s awesome. Thanks so much. Thanks for listening. Follow us on all the major platforms, like us, and we certainly appreciate you taking the time to listen to us. My name is Stewart Foley, and this is the Insurance AUM Journal Podcast.