Investments for Captives: Approach to Asset Allocation ... · 1) Asset Allocation for Captives 2) ... A sound and repeatable process is the key to increasing ... market – using
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16th Annual Executive Educational Conference
Investments for Captives: Approach to Asset Allocation &
Market Outlook Wednesday, September 23
9:00am-10:00am
Presenters
David Kilborn, CFA Chief Investment Officer
Performa Limited (US), LLC
Mike Stellato Senior Consultant
The Concord Advisory Group
David Pittman Chief Financial Officer and Chief Operating Officer
Bennett International Group, LLC
16th Annual Executive Educational Conference
Agenda
1) Asset Allocation for Captives
2) Captive Owner Perspective
3) Market Outlook
4) Q&A
16th Annual Executive Educational Conference
Asset Allocation for Captives
16th Annual Executive Educational Conference
Winning the Investment Game
A sound and repeatable process is the key to increasing the odds of portfolio success in any market environment
Sound Governance
Investment Strategy
Strategic asset allocation that matches the liabilities of the asset pool and the financial position of the
organization
Portfolio Execution
Well-defined vendor selection process
‘Best-in-class’ pricing
Decision-making framework for the
organization
Portfolio oversight
These basic elements form the crucial foundation of an investment program for Captives
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16th Annual Executive Educational Conference
Governance Process
• Establish framework for decision making and accountability
• Set a risk budget based on financial tolerance
• Document intentions via formal Investment Policy Statement (“IPS”).
• Oversight and monitoring of portfolio results versus IPS and long-term goals.
• Focus on relevant and productive forward-looking matters
Investment Policy Statement
Development / Revision
Asset Allocation
Manager Due Diligence / Oversight
Performance Reporting
Cost Analysis
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16th Annual Executive Educational Conference
Governance – Effective Decision Making Structure
• Board Responsibilities
– Establish reporting structure and protocol for investment operations
– Establish Investment Committee
– Review and approve/reject Investment Committee recommendations
• Investment Committee Responsibilities
– Recommend investment objectives, policies, and guidelines
– Develop asset allocation and risk parameters for the portfolio
– Vendors selection and performance evaluation
• Staff Responsibilities
– Daily oversight of investment operations
– Ongoing reporting to Board and Investment Committee
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16th Annual Executive Educational Conference
Investment Program Roles & Responsibilities
Investment Consultant Investment Manager Captive Owner
Governance
IPS1 Development & Revision
Portfolio Monitoring & Oversight
Cost Analysis
Audit & Regulatory Filing Support
Comprehensive Reporting
Board / Committee Education
Investment Policy Input for Specific Asset Classes or IPS Development (if no consultant)
Portfolio Reporting
Audit & Regulatory Filing Support
Board / Committee Reporting & Meetings
Regulatory Compliance & Oversight
Daily Accounting
Quarterly & Annual Regulatory Filings
IPS1 Approval
Monthly Portfolio Review
Quarterly Committee Oversight
Strategy
Asset Allocation Modeling & Strategy
Total Portfolio Risk Management
Portfolio Customization
Asset Class Expertise
Underlying Portfolio Risk Management
Advise on Projected Cash Flows & Liabilities
Asset Allocation Approval
Establish Risk Tolerance Thresholds
Execution
Investment Manager Searches & Recommendations
Rebalancing Recommendations
Document Preparation & Staff Support
Discretionary Management of
Underlying Portfolios
Final Manager Selection Decisions
Portfolio Rebalancing Approval
Transaction Signoff
7 1 Investment Policy Statement
16th Annual Executive Educational Conference
Strategy: Asset Allocation
Return Enhancement
Core Capital
Liquidity
Allocation Building Blocks
Liquidity bucket for expected short-term cash flows. Periodically utilized as a tactical investment in periods of stress.
Income producing and low volatility strategies that support underwriting reserves. Provides diversification and safety to the majority of insurance assets.
Total return strategies that seek to grow surplus assets. Equity-like levels of volatility.
• Develop appropriate investment strategies which align with the operating needs of the organization.
• Recognize the importance of risk management.
• Focus on long-term strategy, while remaining aware of short-term market dynamics.
• Establish liquidity for demands of the organization
• Utilize combination of assets that attempts to minimize risk and maximizes return
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Strategy: Insurance Portfolio Evolution
Formation Stage Growth Stage Maturity Stage
Investable Assets
Limited Reserves Reserve Accumulation / Modest Surplus Stable Reserves / Rising Surplus
Risk Tolerance None Low Moderate
Investment Profile
Capital Preservation Growth & Income Total Return
Investment Goal
Minimize Risk of Loss Income Generation Income & Capital Gains
Investment Options
Cash & Equivalents Short-Term Bonds
Investment Grade Bonds Global Bonds
High Yield Bonds Convertible Securities
High Quality Global Equities
Emerging Markets Equities Commodities Real Estate
Alternative Strategies
Typical Investment
Management Structure
Bank / Single Manager
Single or Multi-Manager / Consulting Services
Multi-Manager / Consulting Services
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Strategy: Asset / Liability Matching
Key Observations:
Total Assets: Consist of Reserves supporting company liabilities and Surplus assets
Liquidity: cash supports daily operations
Core Capital Reserves: Investment grade bonds invested across the yield curve
Surplus Assets: Invested for a total return across a diversified opportunity set of risk assets
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Cash
Core Fixed Income
High Yield
Convertibles Real Return
Global Equity
Liquidity
Core Capital
Return Enhancement
$0
$2,000
$4,000
$6,000
$8,000
$10,000
$12,000
$14,000
$16,000
$18,000
$20,000
$22,000
$24,000
$26,000
Assets Surplus/Reserves Asset AllocatonRationale
InvestmentPortfolio
$'s
Th
ou
san
ds
Sample Insurance Company Balance Sheet Assets Reserves Surplus
16th Annual Executive Educational Conference
Execution: Cost vs. Performance
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Items to consider:
• Measurement against peers (percentile ranking)
• Performance: Lower percentile better (higher returns)
• Fees: Higher percentile better (lower fees)
• Goal is to assemble the most efficient mix:
-Performance: Above median (1st to 50th)
- Fees: Below median (51st to 100th)
16th Annual Executive Educational Conference
Captive Owner Perspective
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Bennett International Group, LLC
Background
• Core business is transportation and logistics - not managing investments!
• Celebrating 42 years in business
• Privately Held, located in McDonough, GA
• CEO and President = Mrs. Marcia Taylor
• Annual Revenues = $340 million
• Started 1st Captive in 2004 (domiciled in South Carolina)
• Started 2nd Captive in 2011 (domiciled outside of S.C for diversity)
• Current combined asset base of $17 million
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Bennett International Group, LLC
Investment Program Overview
• First and foremost, leave investing up to the Experts!
• Developed an Investment Policy Statement (IPS)
– A good Investment advisor will assist you with this
• Interviewed several Investment Advisors
– Track record, experience, proximity and “chemistry” matters
• Selected multiple advisors for diversification
– Each follows the same IPS
• Established a reasonable long-term annual return expectation
• Required monthly reporting and quarterly meetings (in-person or conference call)
– Investment Advisors know that we will be monitoring performance
• We invest for the long-term
– Bull and Bear markets are reality – Occasionally we alter Asset Allocation, but we avoid knee jerk reactions to daily swings 14
16th Annual Executive Educational Conference
Bennett International Group, LLC
Evolution of Asset Allocation
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Cash Fixed Income Equities
2008 – 2009 10% 65% 25%
2009 – 2010 5% 80% 15%
2010 – 2011 -- 75%, 70%, 65% 25%, 30%, 35%
2011 – 2012 -- 55% 45%
2012 – 2013 -- 65% 35%
Since 2013 -- 60% 40%
16th Annual Executive Educational Conference
Market Outlook
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2015 Macroeconomic Landscape
• U.S.A. — The U.S. economy
continues to lead the world as the Fed is inching closer to a 2015 rate hike.
• Eurozone — Sluggish growth and threat of looming deflation resulted in ECB QE and negative interest rates.
• U.K. — Improving fundamentals has the B.O.E. looking to raise rates, but still lagging the Fed.
• Japan — Abenomics is in full gear as Prime Minster Shinzo Abe looks to revive the Japanese economy.
• China & India — Looser monetary policy should be supportive of growth going forward.
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Divergent Central Bank Policies Resulting in Strong U.S. Dollar
• The U.S. Dollar Index is a broad
measure of the strength of the U.S. dollar vs other major world currencies.
• As the Fed moves closer to raising short-term interest rates, the U.S. dollar has appreciated dramatically.
• While a stronger dollar is good for the U.S. consumer (increased purchasing power), it weighs on inflation and hurts U.S. exports as they become relatively more expensive.
• The dollar rally has taken a pause as market expectations for a Fed interest rate hike have been pushed back.
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Feelin’ Alright
• The University of Michigan
Consumer Sentiment Index tracks attitudes and expectations of U.S. consumers.
• We care because consumers who report feeling more optimistic are more likely to increase discretionary spending.
• Falling gas prices, an improving labor market, and buoyant equity prices have supported consumer confidence measures in 2015.
• The pain of the financial crisis is ingrained in consumer psychology, but a nice tailwind from significantly lower gas prices should help comfort consumers.
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Small Businesses - Doing Their Part
• The NFIB small business survey
reports on topics ranging from current activity to expectations 3-6 months ahead.
• We care because a positive trend in this series indicates that small businesses are more upbeat about the economy and their own prospects.
• Optimism declined during the first quarter, but has stabilized around 95 in recent months. A trend back towards 100 would be consistent with solid economic expansion.
• Going forward we will interpret small business optimism as a positive signal for job creation and broader economic activity.
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Job Growth is Solid & Claims are Down
• Nonfarm Payrolls tracks
the net change in the number of employees on business payrolls. Initial Jobless Claims measures the number of new unemployment claims filed.
• We care because initial claims trending around 300k is consistent with solid job creation and economic expansion.
• Today, initial claims are tracking well below 300k offering further evidence that the labor market remains in good health, with job creation rebounding after experiencing a slowdown in March.
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Fed Conundrum #1: Unemployment: How Much Lower Can It Go?
• The Unemployment Rate and
job creation are closely watched data series by market participants and policymakers alike.
• The unemployment rate reached a fresh cycle low of 5.1% in August, a level not seen since early 2008.
• Despite the precipitous decline in unemployment, we have yet to see significant wage growth.
• Interestingly, Walmart recently decided to implement higher wages, potentially pressuring other multinationals to follow suit, a positive signal for wage growth looking forward
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The Fed Keeps Moving its Employment Target: Where Have All the Workers Gone? Explaining Slack
• The Labor Force Participation
Rate (LFPR) is the percentage of people 15 years or older who are either employed or looking for work.
• Many cite the recent decline in the LFPR as evidence of the slack that exists in today’s labor market – using it to explain the lack of wage growth witnessed during the current recovery.
• While the cyclical argument certainly has some validity, we note that demographics are changing, and thus playing a role too. The social, economic, and demographic forces that sent the LFPR higher in the 1970’s have shifted.
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Fed Conundrum #2: Inflation Below 2% Target Lower Oil Prices Having an Impact on Headline Inflation
• The Consumer Price Index (CPI)
tracks prices paid for a broad basket of consumer goods and services.
• We care because modern day monetary policy is closely tied to inflation rates, with many central banks adopting inflation targets.
• Recently, headline CPI measures have fallen as a result of sharply lower oil prices.
• While core measures (which strip out volatile components like food and energy) have held up, the lack of price pressures has allowed central bankers to keep interest rates lower for longer.
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Core Inflation: Take Out Food & Energy - Still Below 2% The Fed Remains “Reasonably Confident” Inflation Will Rise
• Personal Consumption
Expenditure (PCE) is the Fed’s preferred measure of inflation.
• Headline PCE has moved well below the Fed’s inflation target, dragged down by sharply lower oil prices.
• Meanwhile core PCE, which strips out volatile components like food and energy, has held up well.
• The Fed continues to characterize the effects of lower oil prices and a stronger U.S. dollar on inflation measures as transitory, and remains “reasonably confident” that inflation will move back toward 2%, a prerequisite for raising rates.
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Wage Growth will be the Next Catalyst: Is it Around the Corner
• U.S. real average hourly earnings
track the year-over-year growth rate of money paid for work or service, adjusting for inflation.
• While rising wages don’t necessarily cause inflation, we are starting to see mounting wages pressures in the U.S. economy - a good signal that broader price pressures are building.
• Income boosts will filter through the economy and provide the backdrop and confidence for the Fed to raise short-term interest rates, not to mention support U.S. consumption.
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Yield Curve: A Tail of Two Ends…
Interest rates are headed higher in the long run, but as 2014 and 2015 show, it’s more than just the headlines, it’s about the curve…
27 Source: Bloomberg, Performa Limited U.S.
16th Annual Executive Educational Conference
Inflation…
Cost of Cash
• Holding cash might protect nominal value (black line), but sitting in cash means losing real value (green line)
• Over time, inflation erodes purchasing power
• Example – Holding $1,000 in cash since 2005 would result in a value of roughly $800 in 2015, adjusted for inflation
$800
$825
$850
$875
$900
$925
$950
$975
$1,000
Dec-04Dec-05Dec-06Dec-07Dec-08Dec-09Dec-10Dec-11Dec-12Dec-13Dec-14
Do
lla
rs (
US
$)
Years
Value of $1,000 from 2005-2015 Adjusted for Inflation (using CPI 1)
Source: Bloomberg, Performa Limited U.S.
… danger lurking below the surface of every portfolio
1 Consumer Price Index
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16th Annual Executive Educational Conference
Inflation…
Source: Bloomberg, Performa Limited U.S.
1 Consumer Price Index
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$950
$1,000
$1,050
$1,100
$1,150
$1,200
$1,250
Dec-04 Dec-05 Dec-06 Dec-07 Dec-08 Dec-09 Dec-10 Dec-11 Dec-12 Dec-13 Dec-14
Do
llars
(U
S$)
Years
Cost of Cash
• Captives should take steps to defend their capital against inflation
• Ex: A $1,000 investment in a high quality, investment grade bond strategy (as represented by Barclays Intermediate Govt/Credit Index) would have grown to $1,208, adjusted for inflation
Value of $1,000 Investment in Barclays Capital Intermediate Gov/Credit Index
Adjusted for Inflation (using CPI 1)
16th Annual Executive Educational Conference
US Stocks...
Source: Bloomberg, eVestment
• While S&P 500 has done well in recent years…
YTD (8/31/2015) -2.88% 1 Year 0.48% 3 Years 14.31% 5 Years 15.87%
…returns have been led by a small cohort (i.e., 5 stocks combined represent more than 80% of the total return YTD).
• With such a concentrated group of stocks generating most of the performance, stocks that have not participated may offer compelling opportunities for appreciation
… not what they seem
1 1 Year as of August 31, 2015
10.8%
11.0%
12.9%
22.5%
24.1%
0% 5% 10% 15% 20% 25% 30%
Home Depot
Visa
Apple
Amazon
Percent of Total Index Return
S&P 500 Index Top 5 Performance Contributors of the Index 1
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Q&A
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