When I first joined Knights of Columbus in 2005, there were not many life insurers with deep alternative investment portfolios. In a certain sense, everything changed with the Great Financial Crisis and the march into the persistent low rate environment that has been with us for the past decade.
As time moved on after the first rounds of Quantitative Easing (QE), insurers were left to begin considering how to replace the income lost from the march of 5% 10-year Treasuries downward to sub 1% Treasury yields.
Of course, to add insult to injury, we also saw a continued grind of lower credit spreads to make spread product trade at yield level, perhaps, though as impossible to occur.
After thinking about the predicament of low rates, we had to begin thinking about a strategy to replace yield.
Historically, Knights of Columbus was not a buyer of high yield because we were able to generate ample income in the investment grade market and we liked the story of telling our members that we do not purchase below investment grade bonds.
"Of course, to add insult to injury, we also saw a continued
grind of lower credit spreads."
Also, as investment grade yields came down, many insurers delved deeper into the high yield market and we began to see there was less and less value, on a risk adjusted basis, in the high yield market.
As a move to generate income, we decided to move into senior secured loans. We like the floating rate nature of these loans to provide a hedge if interest rates ever actually rise.
Also, as credit people, these loans have maturities that are typically in the two-to-four-year range and that is a length of time that good credit people can evaluate the safety of a security.
Recognizing we did not have the internal expertise on loans, we decided to allocate to our first alternative investment. Our first foray was into a mezzanine loan fund managed by Oak Tree that has since run its course and we were quite pleased with the results.
This structure had “A” and “B” notes with the “A” notes being paid a 10% coupon and the “B” notes serving as first loss notes that receive a lower coupon but participated in the upside of the fund.
"As a move to generate income, we decided to move into
senior secured loans."
As a first alternative, the strong credit track record of Oak Tree and this “A”/”B” note provided credit enhancement that made us believe the structure would provide significant protection. It worked as planned.
I had a background in alternative investments from my days as an investment consultant. It was this expertise that I developed at Evaluation Associates that was an attractive skill set to the Knights.
Several members of our investment staff were interested in being part of the due diligence process and so we began building our alternative investment strategy.
After the Oak Tree fund, we built more exposure in senior secured loans, mezzanine loans, senior real estate debt, and real estate mezzanine. You may be noticing a pattern, credit and high current income. As we established this portfolio, we began to build our real estate equity, infrastructure and also some private equity.
One other area of alternative investing for the Knights of Columbus has been a strategy of purchasing equity stakes in several investment firms.
Our first stake was in Boston Advisors and when the firm decided to sell the high net worth asset management business, we purchased the institutional business and now manage all of equity exposure in house.
"One other area of alternative investing for the Knights of Columbus has been
a strategy of purchasing equity stakes in several investment firms."
Our second stake was in Ranger Global Real Estate Advisors and we have sold that stake to a large real estate manager to help Ranger become part of a larger, fully integrated real estate firm.
This sale was satisfying because we earned a nice profit and helped our business partners land in a seemingly perfect situation for the future of their firm. We have one remaining stake in Welton Investment Partners, and they are performing well.
After starting in 2010, we now find ourselves in maintenance mode with respect to our alternative investment allocation. The Knights of Columbus enjoy high ratings, but with roughly $29 billion in General Account assets, we are somewhat smaller than highly rated carriers such as New York Life, MassMutual and Northwestern Mutual that are all highly rated and investors in a variety of alternative investments.
Based on this size and wanting to maintain our high ratings, we watch our other highly rated brethren and make sure we maintain a similar percentage of assets invested in alternatives.
Ultimately, we decided to focus on using an outsourced model versus building internal capabilities. One of the major reasons we decided on this strategy is that there are times that certain asset classes offer value and other times where they are fully priced.
"Ultimately, we decided to focus on using an outsourced
model versus building internal capabilities."
If you build an internal team, you need to feed the team with assets to apply the strategy. We have had times where we have invested more or less in given subclasses within the alternative investment arena. We are not market timers, but we are value buyers and that leads us to always ask the question: "what is cheap now?”.
I think the secret to our success in alternative investing is that we have aligned with managers where we understand their strategy and risk posture.
Even from my days as an investment consultant, I always told my clients that you should hire managers where you are aligned with their process and philosophy because you will be more inclined to stay confident in them when they underperform because the strategy aligns with your investment views.
While you can only sell alternative investment stakes in the secondary market, and often ad somewhat wide spreads, I still believe that understanding process and philosophy will always be key to building a solid portfolio.
We now have a strategic asset allocation structure within alternatives and will make tactical adjustments based on market dislocations and opportunities.
