Stewart: Welcome to another edition of the Insurance AUM Journal Podcast. My name is Stewart Foley, and I’ll be your host, standing with you at the corner of insurance and asset management, with Lowell Yura, head of Multi-Asset Solutions, North America at T. Rowe Price. Welcome, Lowell.
Lowell: Thanks, Stewart. Great to be here.
Stewart: It’s great to have you. Solutions capabilities are seemingly different depending upon which firm that I talk to, and it means a lot of things to a lot of different people. How do you define solutions at T. Rowe Price? And furthermore, what makes you unique? I think that’s key as well.
Lowell: Well, Stewart, first of all, that’s a great question, and internally, we are a little bit skeptical about the name Solutions. And we can understand that the term is often overused and increasingly being viewed as something new or a fad, because solutions, quite frankly, are commonplace today.
Lowell: Whereas 10, 15 years ago, they were quite rare. So, we have to go out of our way to remind investors that T. Rowe Price has been in the solutions business since the day we were founded. If we weren’t solving problems, we’d probably be out of business by now.
Lowell: So, Solutions is just a label. We really think it’s actually more of a mindset of an organization. And it’s also something that T. Rowe has actually dedicated resources to. And that’s really the only change is now the dedication of resources, or increased dedication of resources. So something that we’ve been doing since the day we started doing business with clients.
Stewart: It’s interesting. I think that you take a little different approach than others I’ve seen, where your team make-up includes some PM’s, quants, actuaries. How does that fit together? The global team?
Lowell: Sure. Well, especially as it relates to the insurance space, but also other types of investors that we work with, we need a breadth of experience. We need people that have had experience running money before.
Lowell: So a number of us have experience running a range of multi-asset portfolios. A number of us have experience as actuaries. Risk managers we have on the team. We have quants on the team as well.
Lowell: And the reason for that is, as you know, all clients are different, and we need to kind of marry the breadth of experiences that we have within the team, and the breadth of experiences that we have across the organization to work with a wide, wide range of clients.
Lowell: And as you know, each client is incredibly different in not only the insurance space, but in every space. And that background I think is absolutely critical to success.
Lowell: The other thing I’ll focus a little bit more time on us is the portfolio management angle. There is a lot of insights that we can come up with for our clients that are challenging to implement and may create problems.
Lowell: And so having that portfolio management experience within the team helps us avoid things that make sense, perhaps in theory, but have a much more difficult time making sense if you have to implement. And particularly as markets have changed quite dramatically and the liquidity of markets have changed dramatically.
Stewart: Yeah. It’s interesting with customization being such a big part of your world, and you have a background as both a PM and you also have a background as an actuary, which I didn’t know until we started talking.
Stewart: And you also mentioned the unique nature of each client, but that also is never more the case than with insurance companies, right? How do you describe your approach to customization?
Lowell: We think of our approach in customization in a couple of different ways. First, it’s stating the obvious. Each investor is unique, but it goes much deeper than that. It’s taking the time to understand what’s important to the client.
Lowell: For example, if you think about, even to simple terms like risk. A lot of people sitting around the table at discussions will answer that question differently. The investment staff will answer that in terms of standard deviation or draw down risk. The product people will answer that wildly different because it has implications for product development, and focus, and features.
Lowell: Then you’ll have the finance angle, what is risk as it relates to earnings? So we have to spend a lot of time up front understanding objectives, but also making sure we understand the definitions to words that can mean a lot of different things to a lot of different people.
Lowell: And so the first step is really a lot of listening upfront and we do our homework upfront about the company and what we can find, but also we want to spend the time really understanding how each individual clients defines very common terms in the industry.
Stewart: It’s interesting you say that, because I’ve been in a lot of situations, I’ve yet to meet an insurance CEO that didn’t say we have a conservative investment philosophy. Right? Everybody says that. But what that means to each one, that’s different. And you got to know upfront, how do they adjudicate success?
Lowell: Well, and I would also add to that, are you conservative in the short term, or conservative in the longterm? And time horizon is another thing that can’t be overstated on how important it is to understand the time horizon and the trade offs associated with being conservative or aggressive in the short term versus being conservative or aggressive in the longterm. Because conservative in the short term could be actually quite aggressive in the longterm, and vice versa.
Stewart: Yeah. That’s a great point. I mean, when you talk about managing assets on behalf of insurance companies, all of the things that you talked about listening to the client and how they define risk in their objectives, is exacerbated by a whole bunch of other things that come into play with insurance companies, that are different than other investors. How do you address that? How do you incorporate that into your process?
Lowell: Specific to the insurance team, when we take the time to work with the client and understand and define what are the objectives? What are the risks of the various stakeholders? It’s then when we can finally move to the next step and taking our understanding of the challenges and the problems.
Lowell: And we’ll also offer our own views throughout this process, but it starts to become a very iterative approach. Once we’ve collected the information on what’s important, we’ll then go back to our shop and work on a solution that we think meets the objectives.
Lowell: But I can tell you from experience, it’s almost always an iterative process. I can’t recall ever saying, “So here’s the answer. Let’s do it.” It’s an iterative process. I think it has to be an iterative process, and I can’t overstate that either, because undoubtedly, and more so in this environment, as you work through different challenges, you come up with things that you might not have expected.
Lowell: It might be the result of an evolution in certain parts of the market that are just different today, and the client didn’t realize that, and need a little bit more time to kind of digest that information.
Lowell: There are certain characteristics of a portfolio that we can dig into in depth that the client may or may not be aware of, or if they’re aware of them, they didn’t realize the impact that they’re having on both risk and return the way they define it. And so you have to take a step back.
Lowell: And sometimes when we have these discussions with clients, it’s often two steps forward, one step back. And as long as we’re kind of making progress towards the solution, it’s worth taking that iterative approach to get to a solution that everyone buys into within our client organizations.
Stewart: Yeah. And I think too, that with an insurance company, and just like you said, it’s not a single answer in a single point in time, not only are your market’s changing, but the insurance company is an operating entity, right?
Stewart: And their results and their financial situation, capital position, tax position, and so on and so forth, changes. So you’ve got this feedback loop that just, as you described, the iterative approach helps you correct and stay on course over time. Is the way that I would think about it.
Lowell: Yeah. And I would say this environment has shed some light on some things that folks have a greater appreciation for. I’ll give you a good example of something that we did recently with a client, and it’s often what leads us to do a lot of our research.
Lowell: And I should have mentioned earlier in the conversation that our primary responsibilities are really to do three things with clients. One is to design solutions for them. Two is to do diagnostics. And three is to provide insights.
Lowell: And the diagnostics and insights often are circular back to designing and managing the portfolio. And where we start in the process is different from client to client.
Lowell: And here’s an example of where we started on diagnostics. The client didn’t come to us and talk about, I need X or Y, we came to them and said, “Hey, we’ve been noticing some really fundamental changes in the equity markets. And we have the tools that we use to run our own internal assets to help you understand if you have some uncompensated risks in your portfolio that we think are really important paying attention to.”
Lowell: And right now in the equity market, certainly in the last two months, you’ve seen this big change between the dynamics between value and growth, for example. I mean, we all know that for 10 years plus since the financial crisis, large cap growth has outperformed small cap value by a large magnitude.
Lowell: And what we’ve seen in the last two months is a pretty significant reversal in that trend, I just looked this up earlier today. Small cap value in the last two months has outperformed large cap growth by almost 20%.
Stewart: That’s unbelievable.
Lowell: That’s an unbelievable number. That’s almost twice as much as the difference between cash and U.S. equities.
Stewart: That’s amazing.
Lowell: You’re talking about two asset classes that, yes, are correlated, but to have a interasset class view have a double the dispersion of cash and equities in a two month period. That’s 20% in two months. I mean, think about that annualized. That’s a big deal.
Lowell: And so what that’s drawn more attention to is, what kind of factors are in my equity portfolio? And are those factors alpha or are they beta? And am I getting compensated for them? And so just running through that, and I have some strong views on that, and our team does too and it’s something we debate all the time. Is a factor alpha or is it beta?
Lowell: And I’ll tell you it depends. It’s beta if it’s structural, and it’s always there. It’s alpha if it’s moving and it’s intentionally moving, because the portfolio manager is finding new ideas and new stocks, and it’s an outcome of that. That’s alpha. But it’s just a structural bias, we want to avoid that. You can get that cheaply. You can get inexpensive factor allocations inexpensively these days.
Lowell: And so, first of all, foremost, we want to make sure our clients are getting alpha out of their portfolios. But secondly, we want to make sure that they’re aware of their tilt in their portfolios, particularly at inflection points like we see today, because even just a modest tilt can result in hundreds of basis points in a short period of time in environments like we’re seeing today.
Stewart: It’s interesting that you bring that up because if we went back 12 months, I think you’d have a really hard time having anything that indicated the level of market dislocation that was coming. Right?
Stewart: We had a very, very difficult spring, COVID-19, I’m not sure that we still have our arms around how big of an impact that’s going to have. So what do you see as some of the main implications of the current environment that we’re experiencing?
Lowell: Yeah. And this is something we just mentioned one. I would say there’s a couple others. Look, I mean, everyone is talking about the low yield environment and it’s funny to reflect on how we felt a low yield environment in 2008.
Lowell: And a former colleague of mine just sent me a Society of Actuaries presentation. And trust me when I say this, I’m a recovering actuary, I don’t read Society of Actuary publications very often. But they sent it because they were talking about the low interest rate environment in 2002, when I think the 10 year treasury was probably around 6% or something lighter, 5%. And I said, “God, hindsight is fascinating.”
Lowell: But nevertheless, when we think about this environment and low rates, it’ll be interesting what we think is a low rate 10 years from now. How are we going to beat Japan and Germany, and maybe a 60 and 70 basis point tenure isn’t a low rate environment.
Lowell: But with that said, there is no doubt that low yields create challenges in two ways. One is generating returns from dropping rates. There tends to be a downside cushion there. Two is, what is going on with policy and how does that impact yields?
Lowell: And so those are all tied together. So I would say the current environment has really a couple major implications. One is just the fact that, for insurance companies, what are the yields available today?
Lowell: But I think one thing that needs a lot more attention is thinking about how policy influences asset prices. We saw in this environment, the Fed], and actually the ECB as well, doing, I don’t know, 15 days, 20 days, what took about a year to do in 2008. And I think that surprised a lot of people. And what was the impact of that?
Lowell: The impact of that is that we had to toss out rules of thumb that are really important for insurance companies. What defines a wide credit spread? Particularly for high yield? Spreads didn’t blow out anywhere near as much as they did during the global financial crisis. They barely blew out as much as they did during, we had a high yield issue when we had the energy sell off a few years ago.
Lowell: And so it’s a very different world, with a very different policy environment. So we need to think about that. I would also say insurance companies themselves are changing the dynamics of what’s a widespread, because we often see insurance companies jumping into certain asset classes to be a provider of liquidity when spreads widen out.
Lowell: So you have policy changing asset market prices, and you have the participants in the markets changing them. And insurance companies are a good example of ones that will generally buy up yield when that opportunity exists. And that has changed the dynamics.
Lowell: And so what do we have to think differently about what is a inexpensive high yield at the top level, and what is expensive? And so I would say that environment, I think, is something that we want to spend a lot of time on, whether it’s equities or fixed income.
Stewart: So it’s a very interesting point, and I’ve talked about this prior, the way that a regulator looks at an insurance portfolio and assigns capital charges, the way that that’s done is certainly in the context of trying to protect the policy holder, right? That’s the overarching idea.
Stewart: And they assign these capital charges where high-grade fixed income has a very low capital charge, and equity has a higher capital charge, and so on and so forth. However, given as low as rates are, I would argue, this is the Stewart Foley opinion of the day, that the risk trade-off between those two things is different than it would be if rates were higher.
Stewart: So the question then leads to, what role do you think equity plays in an insurance portfolio heading into 2021? We recently heard from your colleague, John Linehan previously, but you have a different perspective, and I’d love to hear what you think about equities in here.
Lowell: Yeah. So you’re going to force me to make my fixed income colleagues mad at me by thinking that there’s a role for equities. That’s the beauty of being in multi-asset. You make somebody happy, but you always make someone mad too. Something goes somewhere and something comes from somewhere.
Stewart: I’m a fixed income geek. I mean, I’m the one brought it up, so if they’re mad, they can be mad at me. It’s okay.
Lowell: I’m kidding. I think you make a really good point there. We did some really interesting research before the drawdowns in February and March looking at high yield, but we decomposed high yield, because I, as a multi-asset investor, high yield is a multi-asset security. It’s a stock, and it’s a bond. It’s at a risk-free rate and the spread. And that spread is basically equity risk, and that risk-free component is treasury bonds.
Lowell: So it is a 60/40 portfolio, and so it should have the highest sharp ratio of just about any asset class out there. And so your point about low rates changing the dynamics of credit is real because now even at cheap levels, or low levels of spreads like we have today, I think last week or the week before we hit the lowest level of spread in the history of high yield, not the lowest level of spread, but the lowest level of total yield for high yield.
Lowell: But that spread, that low-level spread, is on top of a minuscule risk-free rate. And so it’s got more equity risk than it would have at that same level of spread 10 years ago. And so you have to think wildly different about these things.
Lowell: And your point about the regulator classifying them differently is a real problem because the risk embedded in these securities today is different. And I would argue that high yield in general is likely to have, whether…
Lowell: Historically, the high yield asset class has a 0.2 to 0.3 equity beta embedded in it. And when it gets really wide, it gets up to 0.8, 0.9, and when it gets narrow, it gets down to 0.1, 0.2. But I think those are going to be higher. Those equity betas are going to be higher because you don’t have as much treasury bonds in your portfolio because rates are lower.
Lowell: So what does that mean? It means a couple of things. One is, you’re getting proportionately more equity risk potentially in high yield or market cycles. Two is, and this is something we’ve been thinking a lot about, and wrote about this, is that the payoff profile for fixed income is very different depending on the starting point of spreads.
Lowell: And it makes a lot of sense, right? When spreads are narrow, they’re like a compressed spring. They can’t be compressed anymore. There is a natural floor. I mean, they could go to zero. Technically that high yield issue can become a zero spread. But if it’s four to five to start with, it can’t go past zero, but it can go to 1,500, even in this new policy world. Right?
Lowell: And so that’s an asymmetric payoff. When spreads are a thousand basis points, yeah they can get wider, but I’m collecting a nice coupon and there’s a better chance that they’re going to get narrower. So I’m going to collet the coupon and I’m going to collect capital gains on that spread narrowing.
Lowell: That’s a great outcome for a high yield investor. So we think that investors might want to think about being more dynamic between their high yield and equity allocation, putting capital charges aside because they are handled differently. But putting capital charges aside, we think there’s an opportunity to have a more favorable return profile for equity risk, whether that equity risk comes from equities, or whether it comes from spreads, by having a little more equity exposure in your portfolio when spreads are historically narrow.
Lowell: And when spreads are wide, sell some equities and buy high yield, and take that favorable, right-tail, fat distribution all day long. And as I said earlier, today you’ve got this unfavorable, potentially unfavorable, left-tail distribution.
Lowell: And those are the types of things that I think are important, at least to consider, and that’s going back to what we were talking about earlier, is those are the kinds of conversations that we think are important to have with clients, because some will say, “Hey, that is something that we want to take advantage of.”
Lowell: Others will say, “No, too complicated. We don’t want to be as tactical. We have to be careful about taxes,” and that’s okay. But that goes back to kind of marrying what we were talking about earlier to this conversation about the current environment.
Stewart: I do think that insurance companies, and I mean, I’ve run money for insurance companies for a long time as well, and you often get this, “Well, yeah. Okay, fine. But we’re just going to keep doing what we’ve been doing.” And I think in this environment, insurance companies have to open up the opportunity set and look more broadly, and more comprehensively to generate returns that will allow them to prosper in this environment.
Stewart: It’s what we’ve been doing all this time seems as though unlikely to work going forward as well. And we’re going to have to take a different look at it, and a top-down solutions approach. Just me personally, it makes sense.
Lowell: It does. It does. And I think, it can’t be done in isolation. It has to be done in the constructs of the constraints and the challenges within the organization that they have to address.
Lowell: But I also think, one thing that I think is important, is top-down investing is really, really, really hard. Macro investing is hard. It’s really hard to have an edge. And one of the things that we’re really fortunate of is where we sit in the organization. As we sit within the investment team, we’re housed within the multi-asset division, we are portfolio managers, we are researchers, we are solutions providers, but we also work really closely with our bottom up security selection folks.
Lowell: And I have to say the importance of marrying top-down and bottom-up has never been more important, because when you have a really strong equity franchise, which T. Rowe undoubtedly has, and the best analyst in the world, and I have no problem saying that, they will pick up on macro trends much quicker than you will be able to pick up macro trends by just looking at it without looking at the securities.
Lowell: And one example of that is, take European banks for example, how do you understand a top-down view on Europe versus the U.S., whether it’s in credit or whether it’s in equity, if you don’t have analysts looking at what’s going on within those European financial companies. What’s going on with the balance sheets, how is management dealing with the various challenges that they have within the Euro zone?
Lowell: You need to kind of blend those two. And it is so important to have that flexibility from the top down to make these asset allocation calls, but we recognize how different it is to do without also having that bottom up expertise, to be able to make those decisions, and to think about how the future is going to be different than the past.
Lowell: And that’s something that we are super cautious about with regard to quantitative data. We think a lot about the intersection of quantitative and judgment. And there’s a great book out there that I always say people should read because there’s a lot of people in my organization that love data. And I say, “You need to read this book called The Tyranny of Metrics.” That’s a shameless plug. I have no idea who the author was, but it did great.
Lowell: And the point I’m making about The Tyranny of Metrics is, metrics are great, but they can lead to really bad outcomes if you don’t think about how things can be different, or the consequences of metrics.
Lowell: And the examples I gave about high yield spreads, in thinking just using a historical average spread is probably completely inappropriate going forward. What makes a stock cheap? Do I want to look at the PE ratios before we add a backstop like we do with the Fed?
Lowell: Yes. Fundamentals do matter. And in the long-term they matter, but you could be giving up a lot of returns by just relying on PE as an issue to determine if stocks are expensive. So the game has changed.
Lowell: And also, the constituents within various asset classes have changed dramatically. So take emerging market debt for example, using the average yield on the emerging market debt index, whatever index it is, local, corporate, hard dollar, soft dollar, it doesn’t matter, if you use the comparison to the past and don’t readjust the constituents for the issuance trends, you’re comparing two wildly different markets. And we have to think about that.
Lowell: Also, a lot of the countries that were emerging 15, 20 years ago, have emerged. They still may be classified as emerging, but they’re truly actually comparable with developed market counterparts. They’ve actually gone through that cycle.
Lowell: So sometimes the index providers are behind, and that’s a really important point about what it takes to make good top-down decisions, and add that flexibility to the toolkit for an insurance company. Because every basis point matters. Every basis point has an impact on earnings. Every basis point has an impact on profitability, et cetera.
Stewart: It’s good stuff. I really appreciate you being on. It’s nice to get to know you. You’re a Chicago guy. I’m a Chicago guy. And every time I do a podcast with somebody, I learn so much, it’s great to be able to speak with people who are running groups and are experts in their field. So thanks very much for being on.
Lowell: Great, thanks for having me, Stewart.
Stewart: It’s worth pointing out, you’ve been on Bloomberg, you’ve been on CNBC, and now you’ve been on the Insurance AUM Journal Podcast, so your media career is skyrocketing.
Lowell: It’s skyrocketing, yeah.
Stewart: It’s skyrocketing. You have to. Well, just a couple housekeeping items. We have announced a joint venture with CAMRADATA, which is going to bring manager tools, selection, and evaluation tools to insurance companies, free of charge. There’s more coming on that.
Stewart: If you like us, please follow us on all the major platforms. You can share our posts on LinkedIn. If you have ideas for future podcasts, please email us at podcast&insuranceaum.com. My name is Stewart Foley, and this is the Insurance AUM Journal Podcast.