On the Mind: Thoughts On Topical Investment Issues Across the Industry

Stewart: Welcome to another edition of the Insurance AUM Journal podcast. My name is Stewart Foley, and I'm standing with you at the corner of insurance and asset management with a dear friend, Andrew Coupe. Welcome, Andrew.

Andrew: Stew, it is absolutely great to be with you this afternoon. I've got to be honest when we were talking about this, I've been excited to sit and chat with you. COVID's really slowed down a lot of these conversations. So this is great.

Stewart: Well, it's going to be fun today. You have an interesting background. You're a senior consultant with NEPC. You're an insurance specialist. You've done this for a long time and you have a fabulous reputation in this business. Can you talk a little bit about asset manager trends and consulting trends? What are you seeing right now in how insurers are interacting, or what they're doing?

Andrew: Yeah, I mean, you mentioned we've been in this industry a long time. And it's real funny is I think while we're out on the street talking to people, I mean, your name is still popping up sort of everywhere I look. I mean, you are clearly did a fabulous job with your business as well.

Stewart: That's referred to, Andrew, as shameless self-promotion.

Andrew: Well, whether it's self-promotion or not, I feel like for a cross of asset managers and clients, your name sort of pops up everywhere I turn. So we're clearly both been in the business long enough that things seem to be going well for both of us. But speaking directly to your question, I mean, I think there's been an interesting sort of separation between what's going on with the asset managers and what's going on with consultants.

Andrew: Speaking to sort of our business first and the consulting side, I think we went through a period where, sort of post-crisis, there was a sort of boom in insurers using consultants. And yeah, I think that was the sort of watershed moment for our industry, where prior to that we were doing a lot of core fixed income work. The searches would be sort of pick between the core fixed income managers, and then post-that it really moved to other types of assets.

Andrew: And I think that's sort of the story you always hear of 80/20 in the workload. It was 80% core and then moved over to be 80% other issues for the industry. And I think that's been the real big change. And I think some of that has been just the rate environment and the continued sort of low efforts. But I think there's also been a focus on profitability across insurance companies and sort of, "Do we really need some of the help that they didn't need pre-crisis?" So that's been the most interesting development.

Stewart: It is interesting. You mentioned the rate environment, right? So I think we all know that the 10-year- note is sub-one and probably most of us think is going to stay there for a while. We were just on a podcast with Nico Santini at ProSight talking about his preference for privates over publics. He's certainly not alone. What are you seeing insurers do to combat rates where they are today, and going forward with regard to the direction of the risk profile of these insurance portfolios?

Andrew: Oh, a lot wrapped into that. So, the answer, and I think it ties back to some of the first question on developments within the asset management community because what we're certainly seeing is on the core fixed income side is costs being driven down. And I'm very hesitant to use the word passive because we as a shop don't believe in passive in the fixed income space, there's still value to be added there. But we're certainly seeing the... have an active manager it's almost sort of not as important of which one you choose or have the fit there. Where there's much more time being spent than ever before is on those alternative sides. There's no sense from the industry that people are really looking to risk up, but what I do get the sense is they're looking to change the risk profile and not just sort of plow into equity risk or increase the sort of leverage, but look at, how does that change?

Andrew: And it's the same story that you see every time that yields get real tight is that people are looking at private placements because it's similar credit quality, but the illiquidity can extend private debt for the same reason. And I get the sense it's more of a sort of moving public high-yield exposure into private debt. There's just a comfort level that we're seeing there, much more across life insurers, I think it's fair to say than PNC, but across the industry.

Andrew: And then the final area, which again, always sort of spikes around this time is structured securities. And I think more so than ever before the range of structured securities has really increased. It's everything from the traditional cards and autos, which don't have any value at all into that 1% bucket you're talking about, all the way to alternatives and private debt that are wrapped into combo notes. And everything in between has been a topic of discussion as insurers are just looking for ways to not increase their risk profile, but maybe diversify it.

Stewart: I think that the current frontier, correct me where I'm wrong here, is developments in the structured market. How are you thinking, and what are the newest structures that you're... structures you're seeing in structure? I do my best to word these questions very creatively, Andrew, just so you know.

Andrew: No, it's complex. And it's funny that the work we directly do with insurers is that there's a lot of that sort of parsing between what structured actually means. Because the people who have historically invested in the space are well sort of versed and understand the nuances. But I think there's a large swath of insurers who are maybe hitting it for the first time and like I said, very familiar with ag-type structures but maybe when you get to the private side are struggling.

Andrew: TALF 2.0 kicked off a lot of discussion. I think that really moved and TALF 2.0 played out I think really the way we expected it to, is we loved the idea for insurers. It was a great opportunity. If you can get AAA paper with a six, seven yield. I mean, it was a no-brainer, but-

Stewart: All day long, yeah.

Andrew: ... the warning was always, if the government program works the way it should, if they're successful, there'll be no opportunity to invest because spreads will be driven down and it just won't emerge. It will be a cash investment that's going to be returned to you. And that's really how it's played out is that the thesis was great on it, but the implementation was challenging. It will be real interesting to see if around election time spreads blow out enough that people can put money to work in that space. But what we saw there was spreads blow out on anything that wasn't covered by government program.

Andrew: I mean, esoteric ABS, the street was sort of talking heavily at the end of last year in how that was the new place to put money and, "Oh, there's no risk in here. AAA paper's great." Well, the mark-to-market went crazy in March and April and that's where I think you see the people who really understand their underwriting, who really know what they're buying into, that aren't panicking and sit on that. And I think that the quick bounce back in the market certainly helped a number of insurers.

Andrew: But the topic de jure and the thing we're talking about, I'd say more than anything of this, is the private ABS deals. There are a few providers in the space. It's a pretty tight market and some of the structures are delivering great yields on some pretty safe type of collateral. I mean, it's really there. The challenges in the space are clearly fees. Anything with yield now warrants folk charging fees on the asset management side. And the bigger question and the challenge we deal with as consultants is, how do you model this stuff? As you say, on a traditional efficient frontier, it's really hard.

Stewart: Yeah, it doesn't work.

Andrew: The market assumptions.

Stewart: And to your point, any change in those assumptions gives you a very different or can give you a very different answer, right? It's so assumption driven.

Andrew: Yeah, absolutely. I mean, one of the big things that I know we sort of think about a lot and it is part of the modeling is sort of, "How much of the diversification is really just a lag on mark-to-market pricing?" When things aren't sort of marked daily, you're going to build in diversification that is really sort of accounting diversification rather than true economic diversification because-

Stewart: That's a really interesting point.

Andrew: Yeah, and it's something that I think insurers are well aware of and think about, but as sort of being a asset allocation provider to companies is something that you need to sort of get in your head is, where diversification and where optimization breaks down.

Stewart: Yeah, it's interesting. Now, so the regulators are always part of the story in managing insurance money, right? They're front and center, they drive, they are somewhat making asset allocation decisions on behalf of insurers, right, based on capital charges. And you and I have never talked about this, I don't think, but the risk profile of a treasury at 5% with a capital charge related to it and the risk of having a 77 basis point 10-year with that, there's a difference in the capital charge versus benefit, that the regulator "is trying to promote safety and security of the policyholder." which is absolutely true so the insurance company can fulfill their promises. Hands down, no argument here.

Stewart: But the way in which that's implemented, how do you think... Are the regulators behind? My opinion, yeah they are. It's tough to stay current. How do you think that all this new structure, private credit, whatnot, how is that playing out on the regulatory side?

Andrew: Stew, I just told you about how everyone is listening to your podcast and the last thing I want is a regulator to be listening in and me saying that the regulators are all behind. That-

Stewart: Oh, listen, no.

Andrew: ... might not be great for my career path. That being said, they're managing a rules-based system that they've got to sort of one-size-fits-all. I think it's a really interesting discussion that we've sort of seen develop since private equity money moved into insurance company ownership, is they have ability to do things on the asset front the traditional and certainly the small to mid-sizes have never been able to do. And so the regulators have to find something that fits for everyone and doesn't create an unfair system.

Andrew: So I think there's a reasonable observation that in a low rate environment the regulations have created a dynamic that is dealing with managing short-term risk, managing the sort of the 50% drawdown and the insurer instantly

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liquidity problem. But it's not really addressing the sort of long- term bleed to death problem that is faced by insurers right now, is when you're sort of matching your policies against these life insurance with 4% flaws and things like that, it's like, "There's-

Stewart: Yeah, impossible.

Andrew:.. there's a bleed to death scenario if we go the way Japan does. And that's where I don't think the regulations are necessarily helping. I think the regulators and certainly the rating agencies are being as proactive as they can and-

Stewart: Yeah, I agree with that.

Andrew: ... really working at it, it's like turning the Exxon Valdez.

Stewart: Yeah, it's really true. I mean, insurance companies need enough flexibility and I think the regulators try to work with the asset managers in the insurance community to try and... I think we're all in it together, right? It is extremely difficult to, as you know, write life insurance in this interest rate environment. It's just tough. So I'll touch base with this.

Stewart: Nico just said that he had mentioned that during the COVID drawdown, he had difficulty buying individual bonds to his... He's a hundred percent third-party managed and that they used ETFs as a way to get exposure to some markets where they couldn't get enough liquidity to buy the actual bonds. How do you interact... do you interact with ETF used by insurers?

Andrew: Oh, I've only got myself into trouble with some bold comments on ETFs in the past and I take the risk of going down there again-

Stewart: Andrew, we promote bold statements here on the Insurance AUM Journal podcast. So let it fly.

Andrew: Yeah, I'm not sure my boss is promoting us to say these things, especially when they get knocks on the door. But listen, ETFs are a great tool. And as Nico sort of highlighted there, using them to access markets on a short-term basis, I mean, that's a really good use of that tool. I think the discussion becomes more challenging when you move into long-term holdings. And I do think it needs sort of separating out across the asset classes. We've looked at equity, ETFs, and passive implementation there and certainly in the US stock. I mean, that's another no-brainer. That is a tool that's there, easy to use, doesn't need thinking about.

Andrew: The ETF discussion prior to a few years ago was a really easy one for insurers. You've got no sort of capital relief, holding it as an equity made no sense. Don't even look at it. That changed when the regulations did and this gets back to your first point of sort of how regulations can adapt and where I think the regulator did a good job is acknowledging that pure bond ETFs shouldn't be held as equity. I mean, they just shouldn't. And so there was a change there. Now that creates the question for insurers of, do we want to utilize ETFs for bonds? Our house view is still that there is some, specifically among any sort of credit instrument, there is still value can be added by an asset [inaudible 00:15:55]. Given how inexpensively asset managers can be accessed in investment grade, having an active, it still makes sense there. Does that completely eliminate ETFs?

Stewart: No, yeah.

Andrew: Not in my opinion at all. I think there's still a place. I mean, even allowing access to ETFs for asset managers as a tool, I think is a good idea, but it creates enormous complexity because you then get down to where do the conflicts lie? Can you buy your own ETFs? Are you buying those ETFs within your broad fee arrangement? Are those costs being passed through? Are asset managers using ETFs for marketing purposes to say, "Hey, we've now got 20 insurers that are using ETFs that maybe wouldn't."

Andrew: And it's a constant question in the back of people's minds that I sometimes think the juice just isn't worth the squeeze. Is it worth having to go through these mental gymnastics? Right now, I sit on the side that, no, I don't really think it is. But as Nico lead out there, using it for a sort of access into a market and coming out, I think is a great tool.

Stewart: Well, it's interesting. One of the things I agree with you, I think ETFs certainly have their place. And I think particularly in, you mentioned, you kind of referenced this regarding private asset classes, but I think it's fair to say that smaller insurance companies can face challenges with getting diversification on a bond by bond basis because as a fixed income geek myself, there's a pretty big price to pay for odd lot bonds. And you can get around some of that. My intention is not to pick on regulators, but at the end of the day, when you have a look through in one segment and then you have some at the state level you have opacity with regard to issuer concentration limits, that can create some issues that are maybe unintentional, but something that I think probably needs a closer look.

Andrew: Stew, once again, your insight is fabulous because it hits exactly what I talk about with my habit of running my mouth and not offering a new discussion. Because that's such a good point is there is absolutely no question that as the asset size gets small enough, ETFs just become again, a really easy use. You're totally right. I mean, the last thing you want do. I've got a couple of clients who have small subs where it just doesn't make sense to use our blocks. So yeah, it really doesn't. And that's a really good use of ETFs as a sort of, "Hey, we can fit here."

Andrew: Back to the nuance. I do get worried that sometimes there is a sort of over-thinking goes on across small insurers and they say, "Hey, now we can get a illiquid allocation through ETFs." Again, when you're not sophisticated enough to sort of take those assets on the balance sheet in a downside scenario, that worries me a little bit more, but yeah, your point is real well taken.

Stewart: And I mean, I think from a safety aspect, right, the liquidity aspect, you've got a lot better liquidity in some of those ETFs than you would in odd lots as well. But so last topic, OCIOs for insurance insurers. Outsourced Chief Investment Officer as is sometimes the case, done outside the insurance industry more than inside the insurance industry. I can make arguments on both sides of this. What's the latest in OCIO for insurance companies?

Andrew: I think we're getting back to hot take space again.

Stewart: This will be in the vignette where I get the hook to try and get people to listen. Ladies and gentlemen, what's coming next, this is the hook. Hang on. Here we go.

Andrew: So your statement is right. I mean, relative to pensions and other investment types, the insurance industry has clearly not moved into the OCIO space as heavily. I know another one of your podcast guests used the old idiom that once you've seen one insurer you've seen one insurer. And that plays out. I mean, from a sort of-

Stewart: That's so true.

Andrew: ... philosophical in an OCIO product, the attractiveness from a provider is that you can sort of build a best in class portfolio and then transport it across clients. Well, that just doesn't work for insurers. Really difficult to do. So the function of OCIO has to be a customized approach and can we customize what we do. Challenging for anybody to do and sort of eats away at the improved profitability that it is a trend for providers. Now, move beyond that and then you think about back to regulation is insurance portfolios, by and large, are 80% fixed income, 20% risk assets.

Andrew: Charging the fees out there for OCIO is tough to do on a tightly feed, fixed income piece. I see OCIO making a ton of sense on the surplus assets and the risk assets side, having some sort of help and support where an insurer may not have the resources and they may need to move quickly. It makes a ton of sense, but the broad sort of true OCIO I think is a tough idea. And now we get back to your very first question of sort of insurers versus consultants and sort of that gray area, because sometimes the asset managers have the bond desk, so they can reduce the fee there. But then you come to offering the surplus assets and are you going to only use proprietary, are you going to explore research, do you get best in class? It's a huge question mark out there.

Andrew: And then on our side, on the consulting side, you've almost got the converse is that we are completely independent and completely offer the surplus assets and you know you're going to get best in class there. But we struggle to solve for, okay the fixed income side and how an OCIO overlay makes sense. My view is I don't think anyone in the industry has nailed that down yet. I think it's still developing. And I think he's going to be a really interesting topic. Again, I'd love to hear your thoughts, Stew. I mean, you speak to people on both sides of the fence. What are you seeing? Where do you see it?

Stewart: It's tough. Where I think it is, is it's really hard and I understand why. I think it's hard for insurance companies to let go of that control. I think it is the fear of a surprise on the investment side. And to your point, the insurance companies, the different capital positions, the different lines of business, the different tax positions, the different risk tolerances is a heavy lift as a CIO, an Outsourced CIO. It's a heavy lift to really get close to all those issues for multiple insurance companies. It's a challenge and it's not nearly as profitable as it would be if you were able to take a best in class solution and apply it across more than one place.

Stewart: I think it's a hard problem to solve. We're going to be coming out with some manager research tools and it's the same sort of thing that's been a problem in the insurance business for years is comparing performance across managers. Because you've got client constraints and they're legitimate client constraints. They're publicly traded, they can't take losses for this period, they can't have earnings volatility. And you can't compare that to a total return unconstrained portfolio, right? And it's a challenge.

Andrew: You said something there that sort of triggered something in my head that never really gets covered by anyone as they're talking OCIO, but that's a huge piece as well, is the audit piece. There is at least one big four audit firm out there who are really tight on control of the investments. And it'd be an interesting sort of study to go down, sort of how would they react when they've got some clients that they're saying, "Hey, you've got to have complete control. Your board has to opine on things." To then say, "Okay, now we're handing over the keys and we're going to let a third party do that." I mean, something that never gets covered anywhere and I think would be interesting to see if OCIO suddenly exploded in the space.

Stewart: Yeah, it's interesting because it's like there's an opportunity in the market, you present it, three months goes by, you discuss it, then it gets approved and the opportunity's gone, right?

Andrew: Right.

Stewart: And you're constantly chasing. So I think there's arguments on both sides of that. Here's the question we haven't discussed. I'm going to hurl it at you. So the job market pre-COVID was pretty hot for college graduates. Some of my students were getting multiple offers. They had internships at really good places. So on and so forth. COVID hits, people got their offers pulled, they got their internships pulled, things changed, right? So here you are. And those of you who've never seen Andrew, Andrew is a tall man. Andrew's about 6'7''. And so I see you with your mortarboard on top of your six foot seven head, which has now got to be about 6'9''. And you're walking across the stage and your graduation from college and yourself now says to yourself then, what? What would you tell your 21-year-old self in this environment?

Andrew: This is sort of off-topic and probably off-brand. But first of all, I say to anyone moving into the space or getting there is, first of all, take some time out. You've probably studied your entire life, you're sort of burnt out. And while people are super excited to get straight into jobs, I think there's some level of people hop in just because it's what you do. Make sure what you're doing is a really good step. It's so tough to do because you're getting so much advice from people telling you sort of how to do this. "Do this... Move."

Andrew: Again, everyone is unique. Think about what's best for you. If you need some time take it. I mean, I look back and I would have never thought of it now, but the start of my career, when I first came to the US I did a year of soccer coaching just moving town to town. I look back now and it's like, "If that paid more than a couple of hundred bucks a week I'd absolutely go back to doing that. It was the best time ever." And you never get that back. So that would be number one.

Andrew: And the second piece I would say is spend time talking to people who've been industry practitioners. Listen to what the opportunity set is because what was attractive when I left college just might not be now. It's that-

Stewart: Right. So true.

Andrew: ... those opportunity sets have gone away. So the people who have the best insight onto where things are going are practitioners. And by the way, here's my advice for the college listeners, have these conversations in interviews. Nothing looks more impressive in an interview than, "Hey, I'm thinking about this. I'm thinking about big picture. I'm thinking about trends." Use your interview as an exercise in, "I can think independently. I'm not going to be like everyone else in college. I'm going to ask you." I mean, that was the biggest part because you don't realize as you're coming out of college, that you're valuable and you can add... And people are looking to invest in you as well. So the more you control things, the more you have that conversation, the better things are. And thinking down the line 20 years, what's going to be attractive, where things will be, not just what the hotspot is right now, I think is unbelievably valuable.

Stewart: That is very good advice. You have been so much fun to have on the show. I'm just tickled. I'd love to have you back. We can talk about a whole bunch of other different stuff. We can talk soccer if you want. I know nothing about it, but you know a lot about it. So that would be a great one as well.

Andrew: When we first started chatting about this, it was the start of the Premier League season and United were dreadful. I was trying to avoid the topic, but all of a sudden, things have gotten a little bit better. And it is a topic that now I'd be happy to revisit.

Stewart: That's hilarious. That's good stuff. Thank you for being on. We really appreciate you. It's always fun. So thanks for taking time.

Andrew: Oh, Stew, I've had a ball doing this. It's been great. Put me into your, I'm sure a long line of people who want to do these, because I'd be more than happy to revisit.

Stewart: Thank you so much. Thank you for listening. If you can, if you like us, follow us, please. We're on all the major platforms. If you have ideas for podcasts, please email us at podcast@insuranceaum. I guess that's about it, Andrew. My name is Stewart Foley. I'm your host, and this is the Insurance AUM Journal podcast.