Executive Spotlight: Nazar Alobaidat, Chief Investment Officer of Enstar

Welcome to another edition of the InsuranceAUM.com podcast, the home of insurance asset management with Nazar Alobaidat, Chief Investment Officer of Enstar. How are you, man? Thanks for joining me.

Nazar: I’m great. Good to be here.

Stewart: So let’s start off this one like we start them all. What’s your hometown, your first job ever, and I already know your fun fact?

Nazar: Okay. Hometown. Wow. Well, I guess that would have to be Awali, Bahrain.

Stewart: Wow.

Nazar: Bahrain’s a 15 by 20 mile island in the Persian Gulf that was formerly a British protectorate. You may not know it but the US has its fifth fleet there. I wasn’t raised there, but I did live there for six years and that’s where I was born. So I’d say that’s my hometown. I grew up in Germany, actually, after having left Bahrain and was raised there in an American Department of Defense dependent school before coming to the US.

Stewart: Wow. What about your first job?

Nazar: First job was an internship with Deloitte and Touche in Tampa, Florida. So I went to the University of Florida, go Gators, and they had a great accounting school. I think at the time, Deloitte’s CEO, Mike Cook, was a Florida alum. And so, I had a paid internship down in Tampa and then I also continued with them after I finished graduate school in New York in their assurance practice.

Stewart: Oh, good for you. And so, your fun fact is that you’ve just welcomed a new member to your family and you have four kids under four and a half. That’s quite a lot of family activities at the house, right? You’re having a little trouble getting some sleep, I’m thinking.

Nazar: Yep. I was just mentioning to you if there’s a podcast you can point me towards that teaches you how to raise four kids under four and a half, I don’t have much to contribute to that one, but I’d love to listen to it. Yeah, four kids under four and a half. It’s been an absolute joy. With Treasury I bonds yielding over 9%, the next natural thing to do was to have more children given the $10,000 limit. But yeah, we just welcomed her two weeks ago and so far things are going pretty well.

Stewart: Well, congratulations, man. That is great. So can you tell our listeners a little bit about Enstar Group, what it is and where it’s domiciled and just a little bit of background so when we go through our questions it’ll have a little bit more context?

Nazar: Absolutely. So Enstar is a Bermuda-based global provider of runoff solutions, which is to say we acquire and manage runoff blocks of business. So we acquire these reserves from other property casualty companies to provide them with capital relief, and then we’re paid a premium in exchange for taking on that risk. And then my department would invest that premium consistent with what you might expect at a live insurance company. The company has a 28-plus-year history and a global presence, being in seven countries with a little over 800 employees. And I joined about six years ago as CIO from AIG with a mandate to establish an investments function that’s suitable for a growing and complex portfolio. I mean, when I joined six years ago, we were at eight and a half billion in AUM and now we’re at a little over 20 billion and growing.

Stewart: Wow, good for you. So first question on the table, how do you manage the contradiction, you mentioned you were in Bermuda, between US GAAP that doesn’t mark liabilities to market, with Bermuda solvency capital requirement ratio, BSCR, that does mark liabilities in a rising rate environment? So, what financial metrics or objectives are you trying to manage to?

Nazar: Yep, sure. Quick disclaimer before I answer that so I don’t get myself into trouble. The views, information or opinions expressed during this podcast are solely mine and do not necessarily represent or reflect those of Enstar Group. There. I made a few people happy there. So to answer the question, so I find the relationship between GAAP accounting and non-US solvency ratio calculations pretty interesting in the current environment. You’re probably familiar with this, but under US GAAP, your bonds are marked to market. And they’re designated either as trading, where the volatility goes through earnings, or as available for sale, where the volatility goes through OCI. But irrespective, it goes through equity. And most insurers don’t use held-to-maturity accounting, which would allow you to kind of forego that and hold it at an amortized cost because you’re kind of constrained in your trading. So you have your mark on your assets. The liabilities on the other hand are not marked.

So, it creates one-sided volatility unless you make an election of the US GAAP called the fair value option, which most insurers don’t do. So, I think most insurers live with this one-sided US GAAP volatility, which I think most people have ignored in the past few years because it hasn’t been significant. But when you have a 300 basis point rise in rates, it becomes just a tad noticeable. Now, flip over to non-US solvency regimes. When you calculate your capital adequacy and solvency ratios, you do in fact take the current rate environment into consideration when you’re discounting your reserves. And you may have seen this in the pension fund industry where you heard over the past few months that pension funds were suddenly overfunded because their reserves were discounted and therefore carried at a lower value. I think that’s actually flipped back now because their non-core assets have deteriorated. But, let’s just say that under US GAAP you don’t mark your liabilities. For the regulatory regime, you do mark them, at least for changes in interest rates. And so that creates this nice natural offset. It’s effectively a hedge, right?

Stewart: It’s a hedge. Yeah.

Nazar: Your bonds are hedging your reserves and GAAP doesn’t reflect it. Your capital adequacy insolvency ratios do reflect it. And the other thing I would mention is that, as your reserves are discounted and come down, the amount of required capital you have to hold is lower. So, you may very well find yourself, as an insurance company, where your gap equity is just plummeting and your capital adequacy solvency ratios are skyrocketing in the other direction. It seems counterintuitive on the surface but it’s really just a function of the convention you use to discount liabilities. I thought that was very interesting in the current environment.

Stewart: That is a very interesting point. So with regard to portfolio allocation, how are you approaching the portfolio allocation with the volatility uncertainty? What factors do you look at for the decision to de-risk or add risk? How are you looking at things? The public market’s re-priced, private markets haven’t caught up, so they appear to be less volatile, but the question is if that’s true, right? Or is that just a valuation hiccup similar to what you were just talking about with the accounting rules? How do you think about your asset allocation right now given the level of volatility?

Nazar: It’s a great question. This is a tough environment to navigate. Given asset correlations have converged, leaving them “no place to hide”, I’m sure that’s a headline you’ve read plenty of times. And, we’re operating in an environment that hasn’t been seen for decades, where fixed income is losing as much as public equity, and it’s also just moving so quickly, the markets are moving so quickly day-to-day, intra-day, you just question whether your entry point will be a good one as you’re allocating. Interesting point on alternatives. I think oddly enough, alternatives being deemed more risky are one of the few places right now where you might still see some positive year to date results, especially in private credit, private equity, real estate equity, infrastructure.

There’s a big question around whether that’s driven by valuation. And, in my view, I think private markets just don’t reflect on a dollar-for-dollar basis public market sentiment. So I’m going to believe the markets for now. We’ll see how they come out year end, but so far that’s been a great allocation decision for insurance company CIOs. But we do find ourselves in this environment where we wake up every morning, this counterintuitive environment where we are literally hoping for bad economic news. That’s another headline. Bad news is good news. You’re hoping that there’s more unemployment so that we can see a light at the end of the tunnel in this tightening cycle. Just put it behind us. So for an insurance company, I think on the one hand, I have to tell you, we are absolutely delighted that new money can be put to work at these levels.

Stewart: Absolutely. Sure.

Nazar: We have been complaining for years about the low yield environment and how that might force someone to chase yield by risking up. I mean, the number one question I got from regulators and rating agencies over the past few years, every call is, “How are you navigating the low yield environment? Are you chasing yield?” I expect that question’s going to be very different today. It’s going to be, “How are you navigating the rising yield environment?” But today, investment grade assets, and this brings me to my answer around portfolio allocation. So, investment grade assets right now are yielding more than high risk assets were yielding at year end. Take short duration as an example. Short duration high yield. Last year that was yielding around 3.8%. We really like short duration strategies.

Today, the two year’s yielding 4.5%. Triple A CLOs are yielding over 6.5%. Even cash is yielding 3%. So having dry powder no longer comes with as big of an earnings drag as it used to. So I think all of that is really good news for insurance companies given that we can allocate in the ordinary course to investment grade strategies and get a great yield. Obviously, there is the issue of the existing portfolio, which if you invest in fixed income, is likely in a pretty material loss position. But the good news there is that if you matched assets to liabilities, for the most part from a cash flow matching perspective, I don’t think you’re going to be in a position where you have to sell to realize those losses. So I think the unrealized losses we’re seeing on fixed income right now will pull to par over time for most insurance companies.

To answer the original question here around portfolio allocation in the current environment, I think you just obviously have to use judgment. You need to consider your existing risk consumption. That is whether you have room for additional risk-taking without creating an angry mob of ERM people. And you have to consider your long-term strategic asset allocation views. Importantly, have your return expectations for your strategic assets changed that would warrant a change in your strategic asset allocation? And then you have to consider your assessment of relative value between asset classes. And then finally, your view of the macro environment, which changes day by day. So we try to take all those things into consideration in determining how to position ourselves.

Stewart: Alternatives have held up better than public markets. And you mentioned is that valuation methodology driven or is it that they’ve just done better? And that’s going to change your asset allocation, it’s going to actually increase your allocation to those asset classes by nature of their superior performance, right? So how are you dealing with that at the moment?

Nazar: Yep. So I think what’s really interesting is if you look at historical downturns, if you look at how alternatives, specifically private equity, has performed relative to public equity markets in the last several downturns, I think what you’ll find is it’s incredibly interesting and it may absolutely determine your risk appetite for alternatives including private equity is that: it has captured 50% of the public downturns on a lagged basis. So first, it doesn’t reflect the market sentiment because it’s lagged, and when it does ultimately reflect it, it’s about 50% of the draw down, including the global financial crisis. So, as you evaluate your alternatives allocation and you look at history, that should absolutely make you even more in favor of holding some amount of alternatives on your books.

Now, you asked whether … Is it just valuation driven, or are they actually doing better? I think if you think about what’s happening in the public markets now, it’s driven just by public sentiment deteriorating, right? Good companies and bad companies, their share prices are going down because of public market sentiment. And I think less of that sentiment flows through into the valuation models of private equity at least. I think more so for large-cap LBO, just because they have more public comps available that they have to take into consideration. But I think it’s just the fact that public market sentiment doesn’t have as great of an impact on alternatives.

The question you ask is a good one around what happens if your portfolio declines in market value and your alternatives become a larger component. How do you deal with that rebalancing? I think we like to hold public equity as a cushion in the event that, say, our private equity would outgrow our target allocation, we could actually dial down our public equity book. So we view our overall equity exposure between public equity and private equity as one risk factor. And so you hold some liquid high yield, you hold some liquid public equity, you can dial those allocations up or down to adjust for that. Outside of that, if you didn’t have those levers to pull, I think you could potentially find yourself in a tough position where you’re overallocated to alternatives and can’t do anything about it.

Stewart: When you think about the best model for accessing the alternatives market, is it insourcing, outsourcing, consultant? What do you think is the right way to access the alternatives market?

Nazar: So we definitely have given this a lot of thought over the past six years and we’ve had a couple different models. The one I really like is, given the complexity of the alternatives asset class, especially when it comes to modeling projected NAVS, distributions, capital calls, expected returns, factoring it into your budget, I think you have to have an internal team dedicated to the asset class to monitor and diligence all the different Gps, just given that the return dispersion in the alternative space is far greater than in the liquid space.

And so I like the idea of having an internal team to help pick names in what I will describe as the large mega-cap space, the really large, well-established funds. I like the idea of having a team dedicated to doing that. But, I also like the idea of partnering with an alternatives investment advisor, potentially giving them a discretionary or a non-discretionary mandate to pick small or mid-cap names that are difficult to access or capacity constrained, or you just don’t know, who they have tracked and monitored for over 10 years. I think the combination of having those two things gives you a really good balance in terms of sourcing alternative investments.

Stewart: And is there any difference for you in your mind with co-investments?

Nazar: Great question. There is. In my opinion, in order to properly access co-investments, you need to have established GP relationships that you’ve underwritten and you need to establish, use them to establish a sourcing channel to source a pipeline of co-investment opportunities that you can then choose from in order to meet your portfolio construction objectives. So to me, that internal team I just mentioned would be more for picking primaries. Once it comes to co-investments, I think you need additional resources on top of that, people dedicated to managing that pipeline, diligence-ing those existing opportunities, and making sure that you’re not arbitrarily allocating to co-investments, that you’re actually allocating to a predefined target portfolio that you’ve constructed. So I like the idea of additional resources for co-investments.

Stewart: And what about, you mentioned inflation a little bit earlier, what do you think the best way to position the portfolio in inflationary environment given … And obviously, like everything in insurance, it depends on your domicile and the size of your company and the lines of business and so on and so forth, but how are you positioning for the inflation that is so prominent right now?

Nazar: Yeah. So inflation obviously has been one of the biggest topics, just especially because everyone got it so wrong. It was supposed to be transitory a year and a half ago and everyone thought it was transitory and we thought it was transitory and then it wasn’t transitory. But I think positioning yourself for a higher inflationary environment right now translates into positioning yourself for a higher rate environment. So I think there are a few things that you can do. You can hold a portion of your portfolio in floating rate assets. So that would include things like CLO debt, an insurance company favorite. Senior secure middle market loans, so private credit are floating rate and a great hedge of rising rates, broadly syndicated loans.

Other floating rate assets in the structured credit space are great for that. And then on the non-core equity side of things, you can allocate to things like real estate and infrastructure equity. Those are asset classes where that effectively can incorporate inflation into their pricing effectively. So, I think the combination of floating rate assets, infrastructure, real estate, I think those are great ways to manage inflation and rising rates. Obviously, there’s buying treasury inflation-protected securities, or TIPS, but I think you would probably need to do that before inflation becomes a problem as opposed to when you’re in the middle of it. Because it can be really expensive and create a drag on your NII.

Stewart: It just seems like no investment conversation is complete without talking about ESG. And it seems as though, I mean, I’ve heard all sides of this, right, but I mean it seems that insurance companies definitely have a lot of skin in the game with regard to climate change in particular. So what metrics are insurance companies looking at, and how are you integrating it into your portfolio management?

Nazar: Sure. ESG is definitely a priority at Enstar and that has been evidenced through the allocation of human resources, financial resources, to advancing our ESG initiatives. On the investment side, we’ve contributed to those initiatives and we’ve taken some actions, which I think are fairly common in the industry. So we currently monitor our ESG metrics holistically. That would include ratings, we perform climate stress testing, greenhouse gas emissions. We’ve taken it a step further and implemented a minimum average MSCI ESG rating across our core fixed income portfolios. And Enstar is a hundred percent outsourced. So we liaise with our core fixed income managers to adjust the benchmarks to create those minimum ratings.

We’ve also agreed to implement future passive public equity exposure via ESG oriented exchange traded funds. So one thing I should mention is that a few years ago we moved away from active public equity management to passive public equity management. And that was largely driven by an analysis that suggested that only 20% of active public equity managers beat their benchmarks. And how comfortable are you that you had successfully picked those managers and allocate to them? So we’ve moved to passive and there are ESG oriented ETFs that are accessible quite easily. And so we’ve started to move towards using those. We also track the percentage of our managers that are UN PRI signatories.

That means you’ve pledged to be part of the UN PRI Alliance. You’ve committed to integrate ESG into your investment decision making. Last couple things we’ve done is we’ve incorporated a responsible investment policy into our broader investment guidelines. We’ve implemented manager scoring with regards to ESG adoption and that we conduct on an annual basis using the ILPA ESG assessment survey to score the managers. And then we’ve also allocated within our private equity program to an impact fund. So there’s actually quite a bit that we’ve done and we managed to do all of this all over the past year and a half. So we’ve really come quite a long way since we first started looking at ESG.

Stewart: You’ve done a lot. That checks a lot of boxes for sure. It’s always interesting. It seems as though the regulator is going to start asking for more information around ESG. And the question is: is there enough data available on the investments that you have to make that possible? I mean, that’s a real issue, right? Is this the availability of data?

Nazar: Data availability is the number one constraining factor. Yeah. We buy data, we buy ESG data. I mean, we leverage our external managers’ data, but given we have multiple managers, it makes it difficult to view our portfolio holistically. So, we have taken the additional step of just purchasing ESG data ourselves for the entirety of our portfolio. We do feel comfortable now that we’re able to report on everything that’s required externally as well as what we’ve decided internally too.

Stewart: And so just last question, what are your views of using derivatives to manage either interest rate credit or equity price risk, especially in the current environment? Or do you think that they are an appropriate tool for an insurance company portfolio?

Nazar: I am a huge fan of using derivatives when they’re used appropriately. I think derivatives are an excellent risk management tool in isolating the risk that you want to manage. And I’ll just give you an example. I expect a lot of folks are evaluating their current duration positioning in the current environment. And there are a couple ways you can adjust your duration positioning. You can either rebalance your portfolio by selling assets and buying assets, or you can use an interest rate swap or other interest rate hedge. Now, if you reposition your portfolio, you’re not just impacting your rate positioning, you’re impacting credit. You’re impacting your asset allocation. You may have multiple unintended consequences and transaction costs, not to mention, with repositioning your portfolio in that manner. So I really like the idea of using derivatives to isolate and manage a risk. Now, derivatives come with their own pitfalls. The most notable being margin calls.

You saw the UK pensions, they faced margin calls from rising rates due to the derivatives that they executed with their banks and they had to pledge eligible collateral as margin and needed to sell. And that created a bit of turmoil in the UK markets recently. So derivatives are subject to margin calls. So there is liquidity risk that you need to be prepared to take. And then there’s also, depending on what you’re hedging, there could be earnings volatility that you’re creating. So if I have a floating rate bond or a floating rate security and I want to swap it to fixed and extend the duration, I’m going to be creating some earnings volatility there because the floating rate asset didn’t have any mark to market from rate changes. Whereas the interest rate hedge will. I really like derivatives. They have been misused a little bit in the past. If you don’t structure them properly, they can be deemed speculative, and they could end up creating more damage than what was intended. So, that would be my view on derivatives.

Stewart: And just to wrap up, this is something that I usually ask every guest, and you’ve been at this a while, and as you look out, if you were coming out of your undergraduate institution with a freshly minted degree, what advice would you give your 21-year-old self today as you look out at the insurance industry as an opportunity set in the investment markets? Where would you focus? What advice would you give yourself?

Nazar: Don’t work at Lehman Brothers in 2006.

Stewart: That is good advice.

Nazar: Yeah, no, I’d say, “Hey buddy, circa 2006, you’re going to work within the investment banking division at Lehman Brothers, and that’s not going to go so well around 2008.” No, that was actually one of the best experiences I’ve had in my career, to be honest. It’s unfortunate that things turned out the way they did, and I ended up at Barclays subsequently. But I guess the advice I would give myself is just to be open-minded and explore other opportunities. Within my career, as a bit of an adventure, I started off as an auditor at Deloitte and then went into a consulting field, then had a unique opportunity to go into the front office within the investment banking division at a bulge bracket investment bank, over to an insurance company within investments. And then ultimately to become a regional CIO and then a CIO. So, I think the advice would be to be very open-minded as you explore career opportunities and to not be afraid to take risks.

Stewart: I love it. Hey man, listen, thanks for being on. I really appreciate it. I know you’ve got a lot going on at home with the new addition to your family and thank you very much for taking the time. It was a great discussion.

Nazar: Thanks for having me. Appreciate it.

Stewart: We have been speaking with Nazar Alobaidat, Chief Investment Officer of the Enstar Group. Thanks for being on. This is the InsuranceAUM.com podcast, the home of insurance asset management. My name’s Stewart Foley. If you have ideas for podcasts, please email me at podcast@insuranceaum.com. Thanks for listening.

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