Stewart: What to do about equities in insurance company portfolios, that's the topic of the day. My name is Stewart Foley. This is The Insurance AUM Journal Podcast. We're joined by Nick Martowski, CIO of Mag Mutual. Welcome, Nick.
Nick: Thanks very much for having me, Stewart. Pleasure to be here. And just a bit of disclaimer, all the opinions today are my own personal ones.
Stewart: Absolutely. These are important things to get out there. So today, we're going to focus on equities, and there's a host of topics to talk about. Where were things when you got to Mag Mutual?
Nick: Yeah. So I joined a company that was, I'd say, heavily influenced from a consulting perspective. And so when I joined, the portfolio really looked like more of a traditional insurance portfolio, where we had a lot of different flavors of equities, obviously a large chunk of investor grade fixed income, a little bit of alternatives, and a lot of active management and some convertibles, some emerging market ... It was a little bit of this, a little bit of that, sort of the longer list that you might typically see in asset allocation.
Stewart: So it ends up being a rather expensive index. Right? I mean, that's where you end up.
Nick: It could be, or just a really long decision chain whenever you want to change the direction of the ship, and there's just too many decisions to make to actually go where you need to go. And so one of the big focus points when I joined was redoing everything from the bottom up and top down strategically.
Stewart: So you always hear people teach investments, diversification, diversification, that gets us to the question around domestic versus international equities. How do you see those two? And what did you decide to do there?
Nick: I'll just tell you where I come out on it, I think 100% domestic makes a lot of sense. And that's probably not the industry standard view. The portfolio that I inherited had a good portion of it in international equities. But there were issues with it. It performed poorly a lot. The active management typically wasn't good. It was expensive, so the question was: Why do we own this? And what are we supposed to do with it? Do we actually need it? We went through a research project, decided it really didn't make sense from any of the traditional lenses you would think about from portfolio management. I mean, it's marketed as, well, it should provide diversification and return enhancement, so that boosts your risk adjusted return.
Nick: When we looked at the numbers, we actually found it increased risk, not lowered it. Diversification was almost zero. It typically went down more than your US equities when they went down, which is not what you want to see. Diversification isn't just: On average, how does it work? I really care about: Does it lose me more money or lose me less if I own it at bad points in time? And then on the return perspective, interestingly when we did this a few years ago, a lot of the major return forecasters had international at higher returns than US. I just found that curious, and so when we did the research into that, it seems like a lot of that was predicated on mean reversion of valuation multiples, which, well, that's hard to call in the short run or the long run.
Stewart: Absolutely. Yeah.
Nick: When we look below that at what you actually own in international developed, it's mostly Japan, the UK, and Europe. And you think about: What is it? Okay. It's terrible GDP growth, terrible demographic trends, sales stagnation, really poor track record of EPS creation, and so that really was why it hasn't done well in the past. And so when we roll forward, what the world's supposed to look like, we don't see those trends really getting better. And then from a sector mix, it's also not good either. It's highly cyclical. So when we compare that to US, we think the US just is a better investment. It's better companies. It's a better sector mix. It's longer term EPS expansion. So we think it actually is just better to own US. There's no question.
Nick: On top of that, by the way, international is more expensive. You pay more to own it. And then it comes with currency risk you probably don't want either. So I hate to say it, but we're all US.
Stewart: And obviously with some good reason. There's a couple other big topics I'll tackle here. One is: What about growth and value or dividend strategies? You hear a lot about that. People, hey, the divided on this company is better than I can do on fixed income, so I'm going to chase that. Can you talk a little bit about growth value and dividend strategies?
Nick: Sure, yeah. A lot to unpack there, let's start with gross versus value. The debate on that, if anything, has just gotten hotter and hotter the more growth has outperformed. And even when we were looking at this two or three years ago, at that point in time, growth had way outperformed. And the question was: When is it going to mean-revert? I think that relationship has totally broken. I don't think we live in a growth versus value world anymore. Increasingly, the companies that fall into the value camp are just worse companies. They are priced that way for a reason. And the growth companies are priced that way because they have so many tailwinds. And so I would much rather be on the growth path despite the fact it obviously looks tremendously expensive, and I don't want to add to it. But over the long run, I think that's going to continue to do quite well.
Nick: It's not to say value hasn't done well, the value indexes, especially S and P 500, are still a very solid set of companies. But you can actually not make either decision if you just own the S and P 500. And I think that is our preference, is just stay in the center, not try to time those factors. They'll get worked out over time.
Stewart: Okay. So you've led me to my next major topic, active versus passive. So I don't know why, but right before we got on this podcast, this notion hit me that if you're owning an index, you are somewhat dollar cost averaging momentum. Right? Does that make any sense?
Nick: I mean, yeah, it does make sense because that's what's happening. The momentum companies are just taking a bigger and bigger share of the index. Granted, in the S and P 500, you own 500 stocks, depending on the day. So you still have a lot of diversification. I'm actually okay with that. I've thought about: Well, if we do like growth and we think that's the long-term place to be, should we own that in a more concentrated form and just smaller dollars? Or does it make more sense to be diversified? For an insurance company, diversification always makes sense, so that's where we come back to.
Stewart: And what about the high dividend approach? How do you see that?
Nick: I've looked at it in the past. I mean, that is one of the stalwart type strategies in the insurance industry. My background isn't 100% insurance, so I kind of look at it as one option on the menu. And historically, there's been a price to pay for that income. And so when I think about equity allocations, I'm really focused on total return. What is the best long-term total return? I think the sacrifice for the groups that pay the high dividends tends to be their businesses may not have the best future potential as others to reinvest in themselves. So it makes me a little bit nervous.
Nick: As well, the other issues today, frankly, is the high dividend payers don't pay a lot more in the S and P 500. The differential might be a percent, percent and a half. Some active strategies kind of juice that up. But at 1.8% income versus your bond portfolio, you're still getting a decent income stream.
Stewart: So you mentioned valuation in saying that growth, even though it looks expensive, you still want to be there. I think probably the poster child for that would be tech. Right? So how do you view tech in the context of an insurance asset management portfolio?
Nick: It's one of the topics that never feels good, but I think it absolutely has a big role to play. In my view, tech is the way of the future. And five or six years ago, I had to go through my own mental evolution on looking at those companies and looking at the valuations, figuring out why they're priced that way, and how the market was evolving. And historically, if you look at some of the most successful companies, they were never cheap. As an investor, if we're only valuating things on the basis of cheapness, we'll probably miss out on tremendous opportunities in equity markets.
Nick: And so the problem with valuing these tech companies is no one knows what they're worth. It's really hard to say what the multiples should be, and no one knows what the earnings are going to be, or the long-term sales growth. And frankly, many of the most successful companies, which are in the S and P 500, have grown so much faster, longer than anyone would've expected. I mean, the predictability factor to me is the number one argument. Analysts can't figure out how good it's going to be. And these companies have outperformed expectations for just so much time. To me, that disconnect just says, "It's too tough to call. We're not going to be able to call it, so we're just going to be in for the ride."
Stewart: That makes sense to me. I'm curious. When you mention your preference for indexing, do you think that there is a role for active anywhere, or is it just straight up index in your mind?
Nick: I think there is a role for active to play, but it really comes down to: How big is the equity allocation? For a lot of insurance companies, it's 20% or less. It may even be 10% or less. And the smaller that allocation is, the more it makes sense to just index it and spend your time on other things that might make sense, like digging out new alternative investment ideas. For our company, our allocation has been up in the low 20s, now the high teens. And so we have one active manager left. It's SMID growth. I do expect there should be some alpha opportunities in the small caps, and that offers different types of exposure to these newer technologies. But the large caps actually behave like small caps today.
Nick: So either way, I think that when you come down to the debate, you also have to ask yourself. Are you actually good at the active side? Can you pick the right managers? Do you have access to the best managers? Can you hang in there during under performance, which may happen for years, and not only at the CIO level, but at the board level? Now what is the comfort level there? And so if everyone's well aligned and ready for the risks that come with active management, it can be helpful. But if not, it's almost certainly going to detract.
Stewart: It's interesting when you have that conversation with a board of directors, and you say, "Equities can be down 30%," and everyone around the table nods their head and says, "Yes." And then equities are down 28%, and that's a whole different conversation. Right?
Nick: Nobody wants to buy.
Stewart: That's right.
Nick: Nobody wants to buy.
Stewart: And it's like, "I didn't think he meant 30%. I thought he was just saying that."
Nick: It feels different in person.
Stewart: Exactly. Exactly. There's a country song like that, You Should've Seen It In Color. It's like, "Yep, I've been there too." So past valuation averages, you mentioned valuation. Can you compare the old versus the new? Or is it a different game today?
Nick: That's a great question. Personally, I think the game is changing. And everybody talks about PE. And okay, what's the long-term PE? And how far are we over it? And where are we versus the tech bubble? But the problem is the long-term average of PE specifically, is a lot of these multiples reflect an index that had a lot less tech historically. And so today, after every sort of recession or market downturn, the tech companies gain share. And with that comes a larger portion of companies at higher valuations. And I think over time, the bias is the S and P multiples are just going to trend up to reflect what's in the underlying index. And so if somebody doesn't adjust for that reality, they're probably coming to the wrong conclusion to just say, "Well, the market's a lot more expensive than it used to be. I don't want to own it here." And so that is the challenge I see and what causes me to keep more of an open mind than I otherwise might.
Stewart: Okay. So here's the fool's gold question. Right? Timing, man, that's tempting. Right? Everybody tells you, you miss five days of the market, and you've missed the vast majority. And yet, people say stuff like, "Man, it feels rich. Feels heavy." You know? I mean, we say it. Right? We say it. We look at the charts. Ooh. So how's your view of timing in here?
Nick: Personally, I've tried to figure out why it is human nature just to speculate wildly on everything, to look at the trends. What I've come back to, I think it may just be the heavy marketing that happens throughout the course of our lives from the active management companies and the trading. And we're sort of sold from day one that we can figure this out, even though it's obviously completely random. Right? But it's like we don't learn, even regardless of how many times we fail, that we're dealing with a roulette table here. That's the reality. We just don't want to see it.
Nick: Now that said, timing can play a role. And I'm not talking about trying to just in out on a frequent basis, but on a longer term basis, you generally know if the market's down 30%, it's too late to sell. You ought to be adding. And there's just too many instances of that. So it's really a question in my mind of: What is the threshold at which you want to add? And frankly, rebalancing solves the problem for investors. If you've got a reasonable rebalancing strategy, you will be taking some off at higher levels, adding it back and lower levels, and that works. But again, the tendency to try to time it, or analyzing, we'd be better off by doing this tomorrow, never goes away.
Stewart: Okay. So the rebalancing strategy that you were mentioning is really a subset of risk management. Right? So I want to back the lens out a little bit. You've got an equity market that's running. You've got obviously that just changing your asset allocation, but you have other parts of the portfolio as well. Can you talk a little bit about your macro risk management, what metrics you think are actually measurable and valid? So many things give you this false sense of precision. How do you deal with that?
Nick: So my absolute favorite for risk management and what to do is looking at back testing. To me, back testing is the ultimate way to evaluate. What is the risk in the portfolio? Specifically looking at points in time where markers were at their worst. From a risk perspective, we probably have seen how bad it gets in equities, in high yield bonds, in IG fixed income. And that is the guide for the future. So you can get extremely comfortable with, here is my likely maximum downside risk. And that's what we look at when we're tinkering with asset allocation, deciding how far we can push out with the risk we're taking. It kind of comes back to that. What's the worst case scenario?
Nick: But the thing is, that can also be a little misleading. That can bias you towards taking less risk that you really should, but you need to be aware of it. I mean, that's what we've tried to incorporate into any change we make. It's painting the full spectrum of not only what we expect will happen on an average volatility, average return basis, but a worst case scenario from a loss perspective. That's where it really kicks in.
Stewart: And not dissimilar to the way that the underwriting folks do it on the other side of the house. Right? They're looking at their downside and they're looking at: How bad can it get? And where are we? And how comfortable are we? Right? I mean, it's a very pragmatic approach.
Nick: And there's more to it than that as well. I mean, we talked about market timing and rebalancing. But ultimately, we have to be good investors. And sort of the definition of being a great investor is knowing when to buy new asset classes or to add to your portfolio. That is sort of a market timing event. But for me, it really comes down to just valuation.
Nick: Now on the fixed income side, I think it's a little bit easier if we talking about spreads and investment grade space. We're talking about yields or spreads in high yield, that decision to me is a lot easier. Think about when we want to add. And are we happy with that risk reward, than it is on the equity side, where you're not dealing with a security that pays you back in five years. You have a much tighter box around the various scenarios you might have in the near future.
Stewart: Do you look at the duration of your liability, your claims liability, vis a vis, your duration of your bond portfolio, are you trying to manage that? Do you not care? I've heard every answer to that question. How do you think about the cash flow liability, schedule P, versus what you're doing on the asset side?
Nick: So it's absolutely a consideration, but it's also somewhat of a moving target in our case. So the average duration of our liabilities tends to be two or three years. Those tend to be related towards paying out claims from lawsuits, which in my mind is probably a hard thing to figure out when those are going to pay out. But we've got a mature book, and we've got a good idea of how that tends to balance out. But we also have a lot of capital beyond the liability. So having extra surplus really matters for insurance companies to figure out how tightly they need to manage that asset liability mix. And because we're also on the shorter end of the duration spectrum, we run a little longer than liabilities because we've got that surplus.
Nick: But ultimately, we also want to do what's right for the company, so does it make sense? It is really painful today to be on the short end of the curve. So anyone who has really short duration liabilities is earning almost nothing. So being somewhere in that intermediate to lower range, it's a little tricky.
Stewart: Yeah. My experience running money myself is, most people are going to run the duration a little long. And then when you consider the dollar duration, it's significantly long, but you're cashflow positive as an operation. And the yield give coming down the curve is so great that if you don't have the need to lock that timing up a little more closely, it's tough to get there. Right?
Nick: Exactly. So from an operational perspective, if you're a growing company, you're a profitable company, all those factors will skew you towards being able to take a bit more risk on the asset side, especially if it pays better.
Stewart: So this is the part of the CIO spotlight that the guest isn't aware of. It's called The Ask Me Anything Segment. So you have a rather unusual path to an insurance CIO seat. How did you get here?
Nick: How did I get here? That could be a long story, but I'll give you the short one. I've had an interesting career, certainly. I've been blessed to have the opportunities I had. I actually started my career in investment banking, fixed income investment banking, in Lancaster, Pennsylvania, which I wouldn't have guessed that's where I would've ended up, especially after really having an interest in investing money ever since I was a kid. So started in Lancaster, PA after I went to college at Franklin
& Marshall, worked in that industry for two years. By the way, driving around the state to go to school board meetings at the end of a long day, in a big state, that is a tough slog.
Nick: Fortunately, I had an opportunity to join a multi-family office shortly thereafter. I'm from Massachusetts. I went back to Massachusetts. And that was the 2008 to 2013 timeframe, where I got to work on just everything from allocator, to direct investments, to multi asset portfolio management, alternatives, due diligence. That really built the framework and platform that spring boarded me forward. As it turned out, in helping manage some income oriented products, that was the exact skillset that insurers want. And so I had the opportunity to join a publicly traded re-insurer, Montpelier Re. I was director of investments there towards the end of my time with them, before they got bought out. But that really got me introduced to the insurance concepts and- the portfolio management from an insurance standpoint. And from that day forward, it sort of followed me around. And I've just come to love the industry because the insurance business is a great business to be in over the long-term. And there's just a lot of great people in this industry as well.
Stewart: It's true. I've got plenty of gray hair, which my wife tells me is no longer premature. That's nice. Thank you. But I've been fortunate to know a lot of really great people in this industry. And it takes a long time to develop the skills necessary to effectively run insurance money. It's well beyond just knowing asset classes and asset allocation. True?
Nick: Exactly. It's fun though. I mean, it is more restrictive. So if you're used to managing money for an endowment or foundation where it's 70% equities, and the Wild West of what you can do, it is more restrictive. But you can still do a lot, and there's usually a lot of assets to invest. And it really matters, I mean, it really matters for the policy holders. It's a huge portion of the company's profitability. So done right, it can be tremendously impactful for the business.
Stewart: All right. Question number two, ask me anything. What's a great long weekend for Nick?
Nick: Oh, wow. I can't even remember what a great long weekend for Nick is like.
Stewart: All right. All right.
Nick: Yeah. I've got two kids under two now, so between the kids and the coronavirus, I don't think I've been out. I can't remember the last time I've been out.
Stewart: Haven't left the house in months. That's great. All right, third question. You're on your graduation day from college, and despite the festivities of the evening before, you are bright eyed and bushy tailed. You are in your cap and gown, looking very smart. And you go, you wait, wait, wait, wait, wait. You go up the stairs, they call your name. The crowd goes crazy. University president hands you your diploma, shakes your hand, quick photo op, and you walk down the stairs. At the bottom of the stairs, you meet Nick Martowski today. What do you tell your 21 year old self?
Nick: I would tell myself to go out there and hustle and chase his dreams, and to go big. I mean, really go big, because I think setting high goals and having passion for what you do, and following that path aggressively ultimately is what helps drive results. And so that's kind of what I did, but that's also, I still believe that's the best advice to give anybody coming out of school, looking at the world open eyed and not sure what they're going to do, or where they're going to go, or where the opportunities are going to come from. I'm a true believer in being a go getter to make things happen for yourself.
Stewart: That's great advice, Nick. Thanks for being on. Nick Martowski, CIO of Mag Mutual. Thanks, Nick.
Nick: Thanks very much, Stewart.
Stewart: My pleasure. Thanks to everybody for listening. If you have ideas for podcasts, please email us at firstname.lastname@example.org. My name is Stewart Foley, and this is The Insurance AUM Journal Podcast