Actuarial Outpost
Go Back   Actuarial Outpost > Actuarial Discussion Forum > Finance - Investments
FlashChat Actuarial Discussion Preliminary Exams CAS/SOA Exams Cyberchat Around the World Suggestions

Salary Surveys
Property & Casualty, Life, Health & Pension

Health Actuary Jobs
Insurance & Consulting jobs for Students, Associates & Fellows

Actuarial Recruitment
Visit DW Simpson's website for more info.

Casualty Jobs
Property & Casualty jobs for Students, Associates & Fellows

Finance - Investments Sub-forum: Non-Actuarial Personal Finance/Investing

Thread Tools Search this Thread Display Modes
Old 10-21-2019, 08:05 PM
campbell's Avatar
campbell campbell is offline
Mary Pat Campbell
Join Date: Nov 2003
Location: NY
Studying for duolingo and coursera
Favorite beer: Murphy's Irish Stout
Posts: 90,306
Blog Entries: 6

Negative Rates Are Placing Pensions in Uncharted Territory
(Bloomberg Markets) -- What may have once been unthinkable is now the new normal. We live in a world of negative interest rates. For pension funds, which safeguard the financial security of tomorrow’s retirees, this means the future is unclear at best. “We are in uncharted territory,” says Innes McKeand, head of equities at AustralianSuper Pty, the largest pension fund in Australia. “Those of us who have been around a long time are struggling to get our heads around giving money to a European government, and they will give you a negative return for 30 years.” What are the other options—go big on private equity? Explore riskier markets? Or should you simply readjust your expectations for returns? Bloomberg Markets spoke with those currently struggling with this conundrum about their subzero strategies.

Ben Meng Chief investment officer at California Public Employees’ Retirement System

“We should carefully study the experience of Japan in the past decades and, to a certain extent, the recent history of Europe. We can gain insight from what’s happened elsewhere.”

Sandor Steverink Head of Treasuries at Dutch Pension Fund APG Group NV

“Investors are forced to look at other asset classes for more attractive returns. This has pushed up prices in all accessible liquid assets and is causing long-term value investors like APG to look even further away, outside the euro zone and in more complex or less liquid real assets.”

Rich RobbenExecutive Director, Office of Investments at Kentucky Retirement Systems

“You can up your risk, or you can just be cognizant of the fact that there’s not that much return available and lower your assumed rates. Our assumed rate of return is the lowest in the country—5.25% for our really poorly funded plans.”

Carsten Quitter CIO at Munich-Based Financial-Services Company Allianz SE

“In the future, we will continue to diversify even more into non-exchange-traded asset classes.”

Andrew Sawyer CIO at Maine Public Employees Retirement System

“We have a pretty big allocation to infrastructure. We think that that is less correlated to the equity markets and provides diversification.”

Herschel Pant Senior Consultant Relationship Manager at AXA Investment Managers

“In addition to negative rates, pension schemes are also becoming cash-flow negative as they continue to mature. This double whammy makes portfolio positioning a greater challenge than ever before—and one that requires long-term strategic alignment to their endgame. Using the right credit can help meet these dual objectives. Schemes must get comfortable with the fact that there may not be one perfect solution out there.”

Mark Delaney CIO at Australiansuper Pty

“We’ve talked about our plans to allocate more to private equity over the next three to five years. As well as being able to stand the relatively illiquid nature of PE, there is also the structural benefit that sustained low debt costs favor the PE business model.”

Bo Foged Chief Executive Officer at Danish Pension Fund ATP

“It’s going to be harder to earn money in the future. That’s why I say we’ve gotten returns in advance.”

Mikko Mursula CIO at Helsinki-Based Pension Fund Ilmarinen Mutual Pension Insurance Co.

“Private credit has been growing in size in our asset allocations. There are products and managers and investment opportunities that’ll provide you a 2% to 3% return. Then if you go to the riskier part of the market, we are starting to see return levels of 10% to 12%.”

Reima Rytsola CIO at Helsinki-Based Varma Mutual Pension Insurance Co.

“There have been some initial talks with banks asking whether we’d be interested in investing if they were to issue [a high-yielding capital relief] instrument. In this environment, we as an institutional investor have a big demand for assets that have a proper yield. But we don’t have any transactions lined up at this stage.”

David Stuart CIO at Hobart, Australia-Based Pension Fund Tasplan Pty

“We would generally reduce exposure to negative yields, though once we’ve hedged back into Australian dollars, even some European negative yield bonds may give us a run-in.”

Ian Patrick CIO at Brisbane, Australia-Based Superannuation Fund Sunsuper Pty

“We like some of the lending in the energy space. We’ve got a fair allocation to midstream and upstream energy assets.”
Ex U.K. Pension Chief Says Negative Yields Will Make You Cry
(Bloomberg Markets) -- Until his retirement at the end of September, Roger Gray led investment management at the U.K.’s largest private pension, Universities Superannuation Scheme, which runs a fund on behalf of 420,000 current and former employees at higher-education institutions throughout the country. During his decade in charge, USS’s assets rose to 73 billion from 26 billion ($90 billion from $32 billion), with an annualized return averaging 10.5%. But his final years were controversial, as a pension deficit and demands for higher contributions triggered the largest industrial action ever seen at U.K. universities. Strikes and protests have erupted at about a fifth of the more than 350 member institutions. In an interview in early September at his London office near the Bank of England, Gray, 62, talked about what he could have done differently and his fears for defined benefit schemes if negative interest rates persist.

Bloomberg Markets: How did USS’s investment approach change under your tenure?

Roger Gray: Before I arrived, USS’s fund was mostly externally managed, even though external managers hadn’t outperformed internal ones. We grew investment team headcount to 150 from 65, increased the amount of management done in-house, and created a professional board to oversee the investment side of USS. Allocation-wise, we’ve focused very heavily in private markets. We added to global emerging-markets equities and fixed income in nongovernment credit. We’ve never been impeded from doing something because we didn’t have the hands or legs to make it work. Now I say to people interviewing here, if you walk through our office, you won’t find people of dubious competence.

BM: Explain the shift into private markets that accounts for more than 25% of the fund’s portfolio.

RG: When I arrived, about 8% of USS’s portfolio was in private equity, infrastructure funds, and property. We were then in the foothills of moving toward a Canadian-style pension manager model. Private markets offer very significant cost advantages if you are a direct investor, as [fees are] quite big. In our case, carried interest would have been hundreds of millions of pounds.

BM: Your direct investment portfolio includes a 10% stake in FGP Topco Ltd., the holding company that owns Heathrow. What is the case for your direct investments?

RG: We always looked for diversity, and U.K. infrastructure is very attractive to us, as it has the same inflation characteristics as our liabilities and is part of a legal and regulatory framework that has operated with a fair amount of stability. Heathrow is a core piece of the U.K.’s infrastructure. It’s capacity-limited, which actually gives it pricing power. With the [planned] third runway, we will defer receipt of cash flow for quite a while, as cash flow will be diverted into building the asset. In all, around 2% of deals we look at turn into a transaction, and we lose most deals we pursue competitively because somebody is always willing to pay more. We tend to find interesting opportunities between the cracks. One example: We acquired [highway service station company] Moto Hospitality Ltd. and syndicated 40% to CVC Capital Partners. It was a transaction that had some infrastructure qualities, it had some property qualities. It was a retailing business as well, but it wasn’t an obvious target for infrastructure or property funds.

“Things move slower here. We are a prudently steered supertanker looking to the long term”

BM: Let’s talk about performance.

RG: Our goal is to achieve 55 basis points per year of outperformance after costs. We have assets with U.K. inflation exposure, like infrastructure, and inflation-linked gilts [U.K. government bonds]. Ten years ago the standard portfolio would have been no leverage, 10% government bonds, 10% property, 80% equities. How have we actually done? If you look at three, five, seven, 10 years, we’ve outperformed 100% of gilts, we’ve outperformed pretty much anything except 100% of U.S. equities. For the five years through Dec. 31, 2018, we were in the top quartile in terms of investment returns, according to a third-party analysis [by Mercer].

BM: Yet by comparison, another U.K. university pension plan, the Superannuation Arrangements of the University of London, has outperformed you in recent years. Why is that?

RG: That’s true; we underperformed compared to them. Obviously, it’s not true every year. They have a very different asset allocation. From their annual report, they have about 35% in return-seeking assets, 25% in equities, 10% in alternatives, and the balance in fixed income. There is quite a large chunk, 35%, in liability-driven investment, and I don’t know what amount of leverage is embedded in that. I guess it could be a reasonable amount, perhaps two times leverage. They will have had the benefit of significantly higher leverage. It just so happens that index-linked gilts have outperformed just about any other asset class, particularly last year.

BM: On index-linked gilts, looking at USS’s portfolio, it looks like you missed an opportunity to profit from their price gains.

RG: If we had known that index-linked gilt yields would go to –2.25% in inflation-adjusted terms, we could have designed a strategy that would have produced high returns. In that environment, leveraged liability hedging is a superb strategy. Cash rates have been low and government bonds have had extraordinary returns. So funds that have had a high degree of liability-driven investment have had a huge tailwind to their performance. We have had some tailwinds. We’ve had favorable markets and have taken quite a return-seeking approach to assets. The best of all would have been to have done both at the same time—take a return-seeking approach to assets and have a lot of leveraged hedging. We could have done more, but we couldn’t have radically done more. One matter is size. We’re not a 2 billion fund where you can move 10% into liability hedging. Things move slower here. We are a prudently steered supertanker looking to the long term. Another matter is price. We were put off by the price of inflation-linked gilts relative to other assets.

BM: How long do you see this era of low- and negative-yielding bonds persisting?

RG: My expectation is that not very long from now, we will look back and say, what was that about? Giving the German government your money for 30 years at –0.3% annual nominal return is an extraordinary thing to do. I suppose it might make sense if we have a complete financial collapse, we have war, huge aggravated uncertainty. And I think that if there’s one point of the current position of defined benefit pension funds that I would want to impress on you today, it is the nub of the pension crisis. At a time when long-dated risk-free assets are paying –2% in real inflation-adjusted terms, the pricing of a new pension promise is extremely high. It has never been seen at this level in history. Mercifully, we have 30 basis points added to gilt yields in September, but August took these gilts down to numbers never recorded previously.

BM: Can you explain why your fund’s deficit calculations vary?

RG: At one extreme you can take USS Investment Management’s best estimates of asset returns over the next 10 to 30 years, and on best estimates we don’t have a deficit. The trustee has to have a measure of prudence when it projects future returns and their deficit number is higher. The most expensive is the buyout method where you take all USS liabilities and ask an insurance company to price it for a guarantee and hold the capital against that guarantee. I don’t know what that deficit is, but it will be a hugely scary number.

BM: If gilts remain low or even negative for a prolonged period that will have to impact your plan’s deficit calculations. What will this mean for defined benefit schemes like USS’s? Already, USS members have gone on strike over increases in contribution rates.

RG: I will cry as I say this. If long-term risk-free assets remain as they are today, just do the math: You may have to pay 50% of salary. It’s a huge strain on affordability. The cost now is huge in order to generate returns while being prudent for schemes with guaranteed benefits.

BM: What do you plan to do after USS?

RG: I would like to do something that is good for the world. I also want to spend time playing the oboe, which once upon a time I considered doing professionally. Music, as is so much of life, is the imagination. Having a sense of destination or orientation is important.

LinkedIn Profile

Last edited by campbell; 10-21-2019 at 08:31 PM..
Reply With Quote
Old 10-21-2019, 08:58 PM
campbell's Avatar
campbell campbell is offline
Mary Pat Campbell
Join Date: Nov 2003
Location: NY
Studying for duolingo and coursera
Favorite beer: Murphy's Irish Stout
Posts: 90,306
Blog Entries: 6

Motives Creating Negative Yields

I previously postulated that negative interest rates are destructive (though profitable) and that they negate human life on a profoundly fundamental level. If they’re so bad, then how and why do they exist? Well, clearly not everyone sees it my way. My proclamations must be hyperbole, right? Not so fast. A look at the holders of negative yielding debt reveals that some potentially perverse motives could be at play.

Plenty of articles explain why investors might buy bonds with negative yields (such as this, this, and this). Never mind the prospect for losing money. Safety, cross-currency bases, and the “greater fool theory” apparently trump the primary purpose of investing. While there’s probably some truth to these commonly given reasons for negative yields, I find them wholly unsatisfactory.

The global bond market is huge. SIFMA estimates its size to approach $103 trillion. While I’ve highlighted the profit potential of negative yielding bonds before, I find it hard to believe that only speculators are behind their absurdity. Luckily DoubleLine Funds helps shed some light on this mystery.

Source: Federal Reserve Bank of St. Louis, The Integrating Investor.
In a recent webcast, DoubleLine Funds presented a breakdown of the holders of negative yielding debt (shown below). What’s immediately evident is that traditional economics—and logic—don’t necessarily apply. The largest holders are Central Banks (79%). They are followed by Pension Funds and Insurance companies (18%). These three institutions dominate the list. Speculators are conspicuously absent, though are likely included in “Other” that accounts for the remaining 3%. So much for safety, cross-currency trades, and greater fools.

Source: DoubleLine Funds
In a way, this is a bittersweet finding. It’s comforting to see that reason still reigns supreme in the capital markets; that investors are still profit seeking and not buying into the tortured logic that underpins negative interest rates; that the central bankers and academics stand alone in their contrived nonsense.

On the other hand, it’s sad to see how much central banks are intervening in a largely freely exchanging marketplace; that manipulation exists to some degree; that bureaucratic whims now pollute the wisdom of crowds created by the decentralized system.

Shown in the chart above is that most holders of negative yielding debt have non-economic reasons for doing so. They are unlikely buyers on investment merits alone. Rather, they are probably motivated by other factors.

Central Bankers Eating Their Own Cooking
While it’s impossible to know the exact motivation for each central bank purchase of a negative yielding security, we do know that policy motivates their actions. Said simply, central banks have no choice but to eat their own cooking. Many—and in particular those in Europe and Japan—set negative policy rates and also purchase large amounts of bonds. As a result, they hold large amounts of negative yielding debt.

Regulations Motivate Insurers & Pensions
DoubleLine identifies insurers and pension funds as the second largest holders of negative yielding debt. Both are very large and experienced fixed income investors. While this may be the case, they are hardly motivated purely by profit.

Insurance companies and pension funds are subject to a myriad of complex of laws, regulations, and bureaucratic idiosyncrasies that influence investment decisions. These are no less realities than profits and losses. While I am hardly an expert in global insurance and pension regulations, one need not dig deep to understand the influence they pose.

Take Solvency II for example. Solvency II is the primary scheme that regulates insurance companies operating in the European Union. Thus, it influences all commercial behaviors from underwriting to investing. The capital requirement calculations are among the most influential parts of Solvency II. Investment portfolios feature prominently into this formula. Sovereign bonds are treated preferentially such that European insurance companies are incentivized to hold them irrespective of their return profiles. It is my opinion that Solvency II and other regulations are an influencing force behind insurance companies’ investments in negative yielding bonds.

“Because Solvency II currently takes a view that [European Economic Area] sovereign bonds issued in own currency are risk-free, there is no charge applied to holding these assets.”

Solvency II Wire
Pension funds are equally subject to complex laws and regulations. They vary from country to country and type to type. The OECD collects and summarizes this data in its Annual Survey of Investment Regulation of Pension Funds report. A read of the Main Findings reveals similar non-economic pressures for pension funds to invest in negative yielding bonds that are divorced from their investment merits. Some excerpts are below.

“Most countries have quantitative limits on the investments of pension funds …
“Investments in equities, in particular in unlisted equities, are capped in most countries …
“In countries regulating investments in bonds, limits are less stringent for government bonds than for other types … [Emphasis is mine.]
“A number of surveyed OECD and non-OECD countries set up limits or completely forbid investment in real estate, private investment funds or loans …
“There are also floors on investments of pension funds in certain asset classes in some countries …
“The legislation on investment regulation also includes specific rules on investments abroad and even prevents pension funds from investing abroad …
“Two main types of limit on foreign investments can be observed in the surveyed countries: i) specific limits by type of asset class; ii) restriction on the overall share of foreign assets …”
Excerpts from the OECD’s Annual Survey of Investment Regulation of Pension Funds report.

While we’ve just scratched the surface, it’s evident that all these rules and constraints create additional incentives for insurers and pension funds to invest in negative yielding bonds. Even if they destroy capital, negative yielding debt can satisfy other commercial requirements that makes them attractive investments nonetheless. Thus, it comes as no surprise to see insurers and pension funds among the largest holders. Those motivated purely by profit have seemingly steered clear.

Investment Implications
What I take from this analysis is that few investors—if any—are lining up to purchase negative yielding bonds on their investment merits alone. Rather, non-economic incentives are motivating behavior. Central banks appear to have the largest thumb on the scale skewing yields to levels as equally absurd as their intellectual underpinnings. Regulation arbitrage likely influences the investment decisions for insurers and pension funds.

On one hand, it’s comforting to see investors rationally avoid the irrational. It’s also useful to see that the conditions creating negative yielding bonds are structural. So long as these regulations remain and the incumbent theories continue to dominate central banks, it seems unlikely that this yield environment will change. However, the markets will ultimately have the final say.

Thus, I believe that a change of minds is a prerequisite for a change in the yield environment. While seemingly unlikely for the moment, political ideas rarely progress in a linear path. Furthermore, a departure from the anemic growth regime could also motivate investors. Negative yields might be here today, but extrapolation can be catastrophic when investing. Vigilance over the intellectual and economic landscape should hopefully telegraph when the environment might change and the full impact of negative yielding debt will be felt.

If you enjoyed this article please consider sharing it with others.


LinkedIn Profile
Reply With Quote
Old 11-12-2019, 03:36 PM
campbell's Avatar
campbell campbell is offline
Mary Pat Campbell
Join Date: Nov 2003
Location: NY
Studying for duolingo and coursera
Favorite beer: Murphy's Irish Stout
Posts: 90,306
Blog Entries: 6
Give me some of that: Trump renews call for negative U.S. interest rates

NEW YORK (Reuters) - President Donald Trump on Tuesday renewed his criticism of the Federal Reserve’s raising and then cutting of interest rates, saying the central bank had put the United States at a competitive disadvantage with other countries and calling for negative interest rates.

Trump in a speech to the Economic Club of New York claimed credit for an unparalleled economic boom, which he said was despite the Fed’s rate increases early in his presidency.

“Remember we are actively competing with nations that openly cut interest rates so that many are now actually getting paid when they pay off their loan, known as negative interest. Who ever heard of such a thing?” He said. “Give me some of that. Give me some of that money. I want some of that money. Our Federal Reserve doesn’t let us do it.”

Thank goodness.

LinkedIn Profile
Reply With Quote

Thread Tools Search this Thread
Search this Thread:

Advanced Search
Display Modes

Posting Rules
You may not post new threads
You may not post replies
You may not post attachments
You may not edit your posts

BB code is On
Smilies are On
[IMG] code is On
HTML code is Off

All times are GMT -4. The time now is 07:28 PM.

Powered by vBulletin®
Copyright ©2000 - 2019, Jelsoft Enterprises Ltd.
*PLEASE NOTE: Posts are not checked for accuracy, and do not
represent the views of the Actuarial Outpost or its sponsors.
Page generated in 0.13465 seconds with 9 queries