Raman Srivastava: At the macro level, we continue to consider the implications of the extraordinary central bank policy response that we have seen.
It seems as if every week there is a new wrinkle and new implication. Most recently it was a spike in US repo rates, but the landscape has certainly changed, and it is new to all of us.
We are spending a lot of time thinking about the implications of the rate and structural environment that we are living in now, versus what we were living in pre-Global Financial Crisis. This is true at a macro level across all regions.
"The landscape has certainly changed, and it is new to all of us."
At a micro level, when you think about the areas where we invest, and perhaps related to the macro level, the concept of liquidity premium is high on the radar.
Many insurance companies take advantage of the ability to take on illiquidity in their asset portfolios since the liabilities are longer in duration. In other words, monetise the liquidity risk premium.
However, as term structure and credit risk premiums have compressed, more of the market has moved towards taking on liquidity risk, as opposed to credit or duration risk.
"We are spending a lot of time thinking about the implications of
the rate and structural environment that we are living in now."
What we have seen is that liquidity risk premiums also are collapsing. This makes life more difficult, since, not only are credit spreads tight, but liquidity premiums in different areas of the market have also tightened.
It is a challenging environment across a number of dimensions, with low rates, flat curves, and tight spreads extending into tight liquidity spreads.
Raman: Although there may not be excessive leverage in sectors at a level similar to what we saw in the financial crisis, we are concerned about the size and structure of certain markets when a recession does hit.
There are going to be pockets of the market which will be exposed when the liquidity environment turns. Lower tiers of the credit market will obviously be at greater risk but all markets will be affected.
If you think about an investment from a pure credit perspective, you may not experience a loss via default, but you may experience much higher volatilities and an opportunity cost if you were to take on credit or liquidity risk too early.
"We are concerned about the size and structure of certain
markets when a recession does hit."
We maintain a relatively conservative portfolio positioning and feel we are well placed to benefit from pockets of the market that may become dislocated when risks materialise.
Being thoughtful about how you measure liquidity and how much liquidity you are selling is important. Rotating too aggressively from liquid instruments into less liquid instruments, to pick up the spread is not necessarily a great investment strategy at this stage of the cycle.
Raman: Many segments of the public developed equity and credit markets are fairly fully valued. On the private side, while there are more opportunities in the credit and equity markets, the spread between private and public markets has decreased.
We still believe that you can find opportunities, but it tends to be in more niche areas.
"Many segments of the public developed equity and credit
markets are fairly fully valued."
For instance, we have had success in the reverse mortgage market in the UK. These are private mortgage loans called equity release mortgages in the UK.
They provide attractive valuations for strong credit quality loans with long duration profiles and hedge our liabilities very well from both an actuarial and interest rate perspective. This market is less efficient and adds a layer of complexity, but therein lies the opportunity.
