Rob: Welcome to Compound Insights, a podcast by CFA Society New York. I'm your host, Rob Rowan. Today, we're speaking with Pete Miller, CFA. He is head of insurance solutions for Invesco's multi asset strategies group. Before that, he was with PIMCO's financial institutions group, where he focused on general account investments and risk managed funds. Before that he worked at The Hartford. He earned his BS from the University of Nebraska.
In my prep for this podcast, I was shocked at how big Invesco’s insurance asset management practice has become. I thought it was important to share this with you all because some of you might not have been up on it in the way I was not. They currently manage in excess of $50 billion globally for 200 general account clients in fixed income, real estate and equity, private credit, including broadly syndicated loans, distressed credit, direct lending and some other stuff we're actually going to talk about today. And the global real estate platform, which we're going to speak a lot about today, is currently $90 billion. So as there is so much uncertainty following that market, that's what we were keen to talk about today.
But Pete, let's start at the top. Let's talk about the global economy. We have obviously rate uncertainty, high equity and fixed income correlation. We got a whole lot of things going on. What's affecting your portfolios now?
Pete: Hi, Rob. First of all, thanks for having me today. It's great to be with you.
You're absolutely right. There's certainly been a lot for investors and for our insurance clients to be thinking about this year. It’s been pretty interesting to see how resilient equities have been just given a lot of the macro uncertainty. I think there still are very real and valid questions around, can the Fed sort of engineer a soft landing and can they continue maybe hiking rates a little bit from here and not really disrupt equities too, too much? And so far the answer has been yes. The equity market has been very resilient. But, I think the flip side of that is we've seen a very volatile backdrop in rates, right? I mean, we saw the 10 Year Treasury get as high as 5% really just a matter of weeks ago and now we've already come back down by 75, 80 basis points in a matter of weeks.
And so, I think there are kind of two buckets that we think about for our insurance clients and what they're largely contending with. Certainly, any insurance company, the bulk of their general account portfolio is going to be focused on fixed income. So the rate environment is hugely important in that context. And for, just about two years now, all the talk seems to have been around handling rising rates. What does that do to our current stock of fixed income assets? If the pace of Fed hikes were to continue in a very rapid fashion that could be negative for general account portfolios.
But the flip side of that is, it does lead to some more interesting reinvestment opportunities and some opportunities for the marginal dollar to get invested in things that maybe were previously not as attractive as recently as a year and a half, two years ago. But now, as I said, where we stand today, rates having come back down very substantially in short order, it feels like we're kind of back to where we were maybe a couple of years ago and a low rate or maybe quasi low rate environment. So I think the short story there is when we talk to insurance clients, they're very cognizant of these cross currents. They're very mindful of what's going on. But you rarely see very material reallocations or changes for a lot of reasons. I mean, there's economic reasons, accounting reasons, income generating reasons that these portfolios tend to be fairly kind of slow to reallocate. So it's really just a matter of taking stock and kind of thinking about where to invest a marginal dollar I think as much as anything.
But the other bucket that we think about, aside from the fixed income bucket, is really whether you think of it as surplus assets or risk seeking assets, things that are really meant to generate return, meaningful return and maybe less of an income focus. Here I'm referring to things like alternatives whether that's private equity, real estate, private credit. And I think, insurance clients like many institutional clients, for the last couple of years have really been thinking about, have valuations kind of caught up to the economic reality? Are there opportunities to deploy now that weren't there maybe as recently as a year or two ago? And that's I think, where at least for us, that's where the bulk of conversations have been. And it's really just a continuation of the theme that we've seen for many years, which is this kind of very, very notable, very consistent trend towards more and more alternative assets. And it hasn't really changed. I think it's again just on the margin, where our insurance clients are allocating dollars and what they're kind of evaluating as the next opportunity has maybe changed on the margin, but it's really just a matter of being patient and kind of not overreacting too too much to the news of the day.
Rob: Right, because at the end of the day, for most of these insurance CIOs, asset allocation is the name of the game and allocations don't change. You might rebalance a little to make sure you're within those frames, but it doesn't really change that often. And if it does, your board's got to get involved. Your trustees are going to want to talk to you. There's a lot of things that have to happen to do that. So that part does make it difficult. But this also raises an interesting question, and I presume you've counseled people on this to some degree and others. How do you know when to change the asset allocation? Does a couple 100 bips matter?
Pete: Absolutely. As I said, I think the first question is really what to do with that marginal dollar. So if you have new flows coming in from organic sales, if you have principal and interest rolling off of your existing portfolio and you can maybe divert that in a slightly different direction than maybe your asset allocation called for a year ago, I think that's kind of the first step or the first place to look. But when it comes to reallocating, as I mentioned, that's of course on all of our clients’ minds. But you do tend to find a lot more constraints around just how much you can reallocate. And there's not necessarily a specific rate level or change in rates or specific market events that would trigger a massive reallocation because you have all those other things to consider as I mentioned, accounting and gains and losses and taxes and those sorts of things.
Rob: Right. And the credit quality, that little thing. I mean, this is exceptionally interesting time. I don't mind showing some of my stripes. Before I came to CFA New York, I worked at one of the larger bond rating organizations on the planet. I worked there during the decline in rates the whole time and we always talked about it as an exceptionally difficult thing to handle for some issuers, not necessarily alternative issuers, but just sort of rank and file state and local issuers. We would have some difficulties when it comes there so we never really talked about what level that would be on. One of the things that is also sort of a macro issue that is gaining a little ground here in some areas of the of the market is regulation. So how are you all thinking about the regulatory environment as it pertains to the macro?
Pete: Regulation is certainly a huge topic for insurers, and that's globally. I mean, I'm based in the US. My colleagues around the world, we all have very similar conversations with our clients globally. And although the exact rules and the exact regulations may vary a bit, the principles are largely the same. It's all about regulators wanting to make sure that policyholders are protected and that the risks that you're taking in this case in the investment portfolio, that you're properly setting aside risk capital and the greater the risk, the greater the capital requirement. That's a fairly intuitive concept that is true globally.
I could speak from my standpoint here in the US, it's been a very active couple of years. I've been doing this for a long time and I don't really remember a stretch as busy as the last call it 24 to 36 months. There's been so much going on the insurance regulatory front, specific to the investment portfolio. And in the last couple of years, we've already had changes around that ratings or designation process, going from a pretty blunt framework kind of bucketing, let's say BBBs across the board in a single bucket. Now there's recognition a BBB+ is different from a BBB- bond and those should have different capital charges assessed as well as something that we've certainly followed closely given our business mix.
You alluded at the top to our large real estate franchise. For life companies recently there was a change to kind of lower the risk based capital requirements on real estate equity. We thought that was a great move and good reflection of the risk there. And now there's continued discussion on other things, which are also very important to our client portfolios. I think one notable thing is the continued discussion around bond definitions versus structured securities specific to structured securities residuals. Should there be a higher capital charge to that kind of equity or residual tranche? And there's kind of a, I would describe it as a stopgap treatment where that's going to get a 45% charge for the next year, maybe two. And I personally think that's going to get reevaluated because again it's a bit more of a stopgap than a fully vetted, fully study change. So I think that's going to continue to be highly discussed and frankly hotly debated because it has been a very, very hotly debated topic. Got very strong opinions on both sides of that argument. And so I think that's going to continue to be top of mind in terms of regulatory discussion.
I think the other one is the very large and increasing role that we've seen private equity backed or alternative backed insurers in industry. Certainly the NAIC has expressed the desire to kind of study that more closely. And I think we're also seeing some similar dialogue in other jurisdictions outside the US. So I would imagine that's going to also continue to be a very big focus of regulators and one that will elicit a lot of opinions on both sides of that.
Rob: Yeah, it's hard to see how that wouldn't come true in part because several of private equity companies that got into residential real estate got egg on their faces in the press, which caused the policymakers to get a move on in there. So now that they're coming into this, it's obvious that it's going to happen more. There's just a lot of real estate carrier stuff in the news with Florida that makes policymakers do things. But look, the private credit landscape is exceptionally interesting right now amid many of the factors we've already talked about. What's your view of the of the private credit landscape right now and how you're advising your clients on investing in it?
Pete: Private credit has been, as we mentioned earlier, amongst other private assets, it's been a huge focus for our insurance, for all insurance clients really. I mean it's along with really, every alternative asset class. Credit naturally aligns with what balance sheet investors are investing the bulk of their assets in to begin with, so there's kind of a natural segue into private credit. But of lately a lot of the talk has been around just the huge flood of capital. It's been a very, very popular asset class in recent years. And so that does kind of lead to some questions around has there been too much inflow relative to the opportunity set? Is there enough deal activity to support that? Are the underwriting standards on these loans up to snuff? And I think the answer, the short answer at least in our view is it depends. Oftentimes they are and of course we strive to be very diligent in our underwriting. But certainly you would see others that maybe are a little more lax and a little more aggressive in terms of trying to land deals. So it absolutely makes sense to be very mindful of that and very cautious and very thoughtful about the managers you're working with, the deals you're underwriting.
There's also, we talked earlier about the real volatility we've seen in interest rates and given that this is largely a floating rate asset class, that's led to a lot of questions around can the borrowers really keep up and does it put stress on their ability to repay? Again, I think there's no obvious black or white answer It's pretty nuanced and the answer is it depends, right? I mean some borrowers are reasonably able to withstand a backup in rates. It doesn't necessarily change meaningfully across the industry the ability to repay. And we haven't really seen a lot of signs of real distress or real challenge there. Of course, there will always be some idiosyncratic situations, but so far it hasn't really been a broad based issue.
So for us, our private credit capabilities, we kind of tend to play in more of the kind of lower to middle market end of the spectrum. And so we're not necessarily competing with some of the real massive private credit shops in terms of the deals that we're underwriting. We try to be a little more targeted in the deals that we do. And so again we think that leads to some benefits i.e. the underwriting that I mentioned. We don't have to participate in certain deals. We don't have to take down deals that we don't necessarily like. And we think that's going to really help and really benefit our client base to kind of go through a full cycle. We expect that will probably manifest in the in the form of better performance over time.
Rob: You're hitting on something I think is exceptionally interesting about the way that people talk about underwriting. Because underwriting, like everything else, is cycle. And we do have some signals right now that the cycle might be a little long in the tooth. But there are people like me included, who were saying that we were long in the equity cycle for about, I don't know, maybe five years before. It's hard to tell when it happens. It's just easy to say where we are, and even that's not always that easy.
But the other thing that is going through a massive change and I think it's related to some of the things you were just talking about is real estate. And you all have a pretty wide area of expertise in this so I'd love to hear your thoughts about real estate. But where do you want to start? Debt, equity, commercial, residential? Anything. I'm ready for all.
Pete: Sure. One of the luxuries that I have in my role at Invesco is our real estate franchise, as you mentioned at the top, it's not only very large but it's absolutely global in nature and the breadth of what we can work with our clients on is almost unlimited. So we have equity strategies in just about every region across the globe and that spans more of the kind of core income producing all the way up through more value add and opportunistic opportunities or strategies where a little more of a capital appreciation play and maybe a bit of a higher return and higher risk sort of construct. And not only that, on the equity side, but we have a very strong commercial real estate debt franchise as well.
And I mean not surprisingly, I'm sure you've heard this from many others, Rob, commercial real estate in general has been, it's been a tough go the last couple of years just coming out of COVID. And tons of very valid questions around what is commercial real estate going to look like over the medium term or long term coming out of COVID? And what's the demand situation? What will leases look like going forward? And I think that's all very understandable, as I said very valid questions, and naturally that's led to maybe a bit of a pause in terms of activity and we've certainly seen that as well.
What I would say though is right now we're definitely already seeing real interest in both equity, but especially in debt. I think our insurance client base is starting to show genuine interest in kind of getting back into the market. And maybe we're kind of reaching a point at which again, valuations are maybe more reflective of reality and you're seeing particularly in the debt space, returns that are very interesting. Call it maybe high single digit returns for seniority or good seniority in the capital structure. And if you think about relative to equity that tends to be more interesting to our insurance clients right now. I think it also ties back to we talked about the regulatory landscape. We're thinking about in the debt space, lower RBC requirements, lower capital usage. And so if you can get pretty high relatively speaking, attractive returns for senior exposure, relatively lower risk as compared to equity and much lower capital charges, it's not really a surprise that that's where we're seeing the most interest right now.
I would also highlight, that's not unique to the US. I mean, we're seeing that from our global insurance client base. Global clients looking for US CRE debt exposure as well as some European CRE debt exposure. And so it makes all the sense in the world to us, and as I said, selfishly, for me and where I sit within the firm here at Invesco it's great that I have the ability to talk to our clients about all these different things because we do have kind of the full waterfront covered at Invesco, but certainly debt is kind of top of mind for our clients right now.
Rob: That's really interesting that they've reached an inflection point at least on the debt side. I wonder if they're interested in any of the sub sectors or are they going across the board to all the sub sectors of commercial? Are they interested in server farms or student housing? What are they going for?
Pete: It's a great question. It's hard to say one particular sector, but I think the one theme that has become fairly notable is just the interest or the desire for, call it, specialty sectors. And so that's kind of a catch all but the point being something that is differentiated and something that is maybe less correlated with kind of the core exposures and the typical real estate exposures that you may already have in your portfolio.
So it's not like clients are coming to us asking for a particular specialty sector. It's more of a kind of catch all like, hey, what sorts of exposures can you get for us that might be less correlated with our existing book? And frankly it can be a challenge because you want to make sure that you're kind of accessing parts of the market that are scalable and that we can really deliver. And, again, we have a large real estate franchise and so we're trying to be mindful of what are those parts of the market that are at the same time both differentiated but also scalable and ones that we think are durable. So you do have to be thoughtful about that.
Rob: Right. The durability comes from the relatively long term approach that most asset owners, particularly insurance companies, come to with these investments, right? They're forecast is at least seven years for this, right?
Pete: Right, exactly.
Rob: Yeah. And if not more. That makes it very difficult in a narrow market. Parenthetically, I would mention that our next podcast is actually going to be on senior living facilities. So we're going to drill down this in our next episode. You heard it here first about. I joked with specialty credit is basically not office.
Pete: There you go. Yeah, that's a good way to put it.
Rob: So this is where I'd like to pivot this a little bit to your process because, boy, you and your team writ large are covering a lot of different things in a lot of different places. And I think some people are wondering how your team is structured? Do you bubble ideas up, down, sideways? Like how does all that stuff work? And because you have a global team, how do you handle the information exchange on a global team basis?
Pete: That is the $1,000,000 question because where I sit, I'm part of our solutions team and the short answer to your question is there is no one way that ideas bubble up, down, sideways. It's really all of the above. And the way I think of it is myself and our solutions team, we kind of sit at the center of all of our investment teams around the firm. And we've talked a lot about private credit, private real estate, but also our fixed income franchise is very sizable. We also have a very big ETF and equity franchise. So I have the luxury of sitting kind of in between all that. And so we get ideas from all of those investment teams, all of those experts in their respective areas. If they are seeing opportunities or activity that might be new, or kind of nascent things that maybe haven't been trafficked in highly, that might be an opportunity that we can bring to our insurance clients.
Conversely, we can go to our investment colleagues and say, look as an example, here's what's happening in the regulatory context right now. Can we maybe repackage something that might deliver the same exposure for insurance clients, but just in a different wrapper or a different vehicle that makes it more capital friendly? So it can go that direction. There's really no limit to where ideas can be sourced or any good idea. We're absolutely open to discussing wherever it may come from. And the way we work with our clients, it's very similar. I mean we in one sense we as a solutions group, we're kind of an extension of our investment teams, but we're also, from our clients perspective, we're an extension of our clients teams and that's really how we kind of bill ourselves and how we kind of offer our services is we're dealing with very sophisticated clients, but our insurance clients, I mean they know what they're doing. They have their views, they have their models, they have their analytical frameworks. And many times, arguably they don't. They don't need help. But the way we frame it is if you would like help, if you'd like a second set of eyes, we're here to do that. If you need help again, packaging something or delivering something in a different wrapper, we're here to help with that.
But, I think the key is we're here to really consult with and partner with our clients as an extension of their own teams and they can kind of point us in the direction that's most helpful for them. And as an example, a newer capability that we've developed here in the last year or two is more of a kind of a multi alternative capability where for let's say our kind of smaller or mid sized insurance clients who maybe don't have the bandwidth or don't have the in house resources in terms of personnel, might be an investment team that's a couple of people, they don't necessarily have the bandwidth to assign somebody to just cover private equity or just cover private real estate and then deal with manager diligence and all the operational elements and dealing with capital calls and distributions and all that sort of stuff. So we've kind of put together a multi alternatives capability where we can deploy and by the way, it doesn't have to be Invesco content. We can utilize other managers capabilities as well. We recognize we're not going to be the best at everything at Invesco. So we can do that on behalf of our clients and really function as kind of a de facto staff member for them and just do some of that heavy lifting to kind of take some of the stress off of their plate while they're still really making a lot of the key decisions. They hold the keys right? They decide what they want to do at the end of today. But it's something that's been really helpful working with really large insurance mandate in this context with a client in the UK. And it's been really rewarding because again it gives us access to a lot of great ideas, to your earlier question, both in Invesco and even outside, and it's a really interesting avenue for us to be working with our clients.
Rob: Yeah. I mean, the sort of insurance comp, insurance book, if you will, that you just described is most of them. Most of them are not the really large firms by definition, right? So this is the exceptionally important thing. And also in the asset categories you just mentioned, there is, to dig into an old statistic word I would use, there's misfit risk or exogenous risk that clips those things and you really need somebody who does that, who lives it because it's all often painfully obvious to them.
Pete: We think so, yeah.
Rob: As we are nearing the end of the year, I know a lot of people are sort of topping up their reading lists and downloading stuff and getting ready for the time off. I wonder if there's anything in particular you've been reading watching, otherwise intellectually consuming as we all have so many options today.
Pete: Yeah, well, it's funny, outside of work, I try to not read finance all the time. I try to broaden my horizons a little bit. So I think the last book I read was Colson Whitehead’s “Crook Manifesto.” He's one of my favorite authors. And that was a continuation, if you will, of one of his prior books, which I loved. And it's very much into the New York mindset which is always interesting to me.
And honestly lately just in the last week, with the passing of Charlie Munger, as an Omaha guy myself, I keenly follow the Berkshire goings on. And obviously he's a very well known guy who was not short on funny quotes and quips and also good investment advice and content. So it's been kind of fun to go back and see a lot a lot of the writings and quotes and clips, video clips of his shareholder meeting appearances over the years. So honestly, I've been consuming a lot of that the last week or so. And as I said, he's provided a lot of fodder, which is both educational and entertaining at the same time.
Rob: Right? It's the best. As a person who's involved in sort of continuing education, that's the best. So thank you for that. And I just want to point out to everyone who's listening to the podcast here today that there’s a little bit of coincidence coming up on Wednesday. Invesco is the sponsor of our event on Wednesday, the 8th Annual Insurance Roundtable. Just before we recorded this, we had 14 seats left for this, so if you’re members out there, thinking about coming, do sign up soon because we're going to be closed soon. And the hopefully we'll see you on Wednesday.
This has been great, Pete. Thank you very much for the relatively broad touches on a lot of things, and it was fascinating to hear about how your team is structured.
Pete: Yeah. Thank you so much, Rob. Really enjoyed it.
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