Gregory H. Cobb, of Sage Advisory Services, provides insights on how emerging and more volatile investment environments require greater care in selecting an investment manager
On the investment side of the house, captives continue to breathe a sigh of relief while methodically enhancing yield profiles and income generation – after more than a decade spent desperately searching for yield, often having reduced quality guidelines and liquidity metrics to capture even the slightest of incremental yield and income.
The recent three-year path to higher yields has not been without its challenges. Surging inflation, an historical period of monetary tightening, loss-constrained portfolios and now radical attempts fundamentally to reconfigure the global trading and financial system have brought an end to a decade-long era of low yields, while at the same time introducing higher levels of expected volatility.
Today, in this emerging environment, investors can couple higher official and risk-free rates with just even modest risk premiums and obtain attractive long-term yields on high-quality, liquid securities – but at the same time, must remain ever vigilant versus unexpected dislocations.
From a “lost decade” to “normalisation” to heightened volatility
It is instructive to view this emerging environment in the context of two distinct periods in the modern history of bonds. The period 1980-2011 saw high yields and income generation, with the general trend of ever-lower yields generating a healthy dose of additional capital appreciation – the so-called “golden era” of bonds.
During the 2011-2021 period, both inflation and bond yields had little room to fall lower, especially as official rates fell to the lower bound of zero. This “lost decade,” characterised by a dearth of yield and income, led to the feverish search for yield via higher risk, more complex, and less liquid securities.
Today, one should not expect a return to either period. Instead, over the coming years, the environment should be more akin to textbook “normal”, whereby fixed income portfolios produce a reasonable and more durable stream of income while providing strong diversification versus higher volatility asset classes. However, normal does not mean quiet! Most institutional investors agree that we have entered a period of elevated macroeconomic and geopolitical uncertainty. Never a dull moment and no place for complacency!
A more selective approach to investment management
As such, captives should be exploring a variety of avenues to build more resilient, flexible and sustainable portfolios while capitalising on new and evolving opportunities. This requires a far more active approach to asset allocation, a more rigorous approach to diversification and the application of more dynamic risk management strategies. For captives, this suggests a successful investment programme will be one that instills a more disciplined and collaborative approach across parent, captive, and investment management teams. With the investment management team at the centre of this triumvirate, insightful manager selection becomes a necessity.
Such selection becomes paramount, considering the need for more active approaches to asset allocation, more rigorous approaches to diversification and the application of more dynamic risk management strategies. However, in many instances within the liability-driven ecosystem of a captive, the selection of investment management can seem an afterthought. Do not be that captive! Make a more deliberate and informed decision.
When selecting an investment manager, there are a number of key considerations:
- Demonstrated knowledge of the captive space
- Deep engagement with the captive industry at large
- Experience in managing the captive ecosystem
- Effective integration with senior management
- Dedicated resources to insurance portfolio management
- Diversified investment solutions across the life cycle of a captive
- Generation of consistent outperformance across market cycles
- Ability to deliver highly customised enterprise-wide solutions
- Relationship management dedicated to the insurance industry
- Cost-effective delivery of all services.
It’s just more fun than it deserves to be
There is no universal captive playbook for investments. Over time, and through the life cycle of the captive, the balance of risk evolves – whether through offered lines of coverage, underwriting standards, reserve development, tolerable levels of surplus volatility or regulatory regimes. It requires an investment manager that takes a more disciplined and collaborative approach in the pursuit of portfolio solutions which are continuously and properly aligned with unique and evolving risk agendas and overall enterprise-wide objectives.
In the end, no matter where a captive may be within its own unique life cycle (de novo, reserve, mature) or where the balance of risk may lie (insurance vs. investment vs. regulatory), each individual captive requires its own unique investment solution. Like all risk professionals say, “When you’ve seen one captive, you have seen one captive.” And that is what makes managing investment portfolios for captive insurance companies more fun than it deserves to be!
[This is for informational purposes only and is not intended as investment advice or an offer or solicitation with respect to the purchase or sale of any security, strategy or investment product. Although the statements of fact, information, charts, analysis and data in this report have been obtained from, and are based upon, sources Sage believes to be reliable, we do not guarantee their accuracy, and the underlying information, data, figures and publicly available information has not been verified or audited for accuracy or completeness by Sage. Additionally, we do not represent that the information, data, analysis and charts are accurate or complete, and as such should not be relied upon as such. All results included in this report constitute Sage’s opinions as of the date of this report and are subject to change without notice due to numerous factors, such as market conditions. Investors should make their own decisions on investment strategies based on their specific investment objectives and financial circumstances. All investments contain risk and may lose value. Past performance is not a guarantee of future results.]
Sage Advisory Services, Ltd. Co. is a registered investment adviser that provides investment management services for a variety of institutions and high net worth individuals. For additional information on Sage and its investment management services, please view our web site at sageadvisory.com, or refer to our Form ADV, which is available on request by calling 512.327.5530.
