Daniel Blamont: The central bank and government support has blurred the lines between corporate risk and systemic risk. It can be a challenge to identify what is the idiosyncratic risk of what we are investing in, versus what is support from external sources.
The issues are how long this support is going to last for, how long it will need to last for, as well as what form it will take. This is a major risk in our portfolio.
"The central bank and government support has blurred the lines between corporate risk and systemic risk."
There are names that were challenged before the crisis and are continuing to be challenged but that have still not defaulted because of this support.
We need to be careful to not just buy every security out there just because the environment or institutional set up provides support.
We want to be able to think beyond the current situation as to what opportunities, names, and sectors will still make sense when this is over.
Daniel: I come from an insurance company and by regulations and habit we do hedge all the duration risk versus our liabilities.
What does happen is that there are certain balance sheet elements, such as the risk margin where you either hedge and take on some capital, or you don’t hedge and the balance sheet is exposed to changes in rates. We try to balance these options and take a total balance sheet approach.
We decide on what metric matters the most. If you have conflicting metrics, you have to use options or a dynamic hedging strategy of sorts.
As rates are getting lower, we are facing second order risks. For instance, the capital that we hold for equity risk or corporate credit risk goes up simply because the value of the assets is going up.
"There are no two ways about it, we have to use
dynamic or option-based strategies"
The exposure to, and interaction with, rates goes up as rates go down; this is what we mean by second order risks.
Being a mainly Sterling denominated business, we previously, did not worry too much about negative rates compared to our Euro peers for example.
Now that rates are close to zero, we consider potentially large drops in interest rates. There are no two ways about it, we have to use dynamic or option-based strategies. But ultimately, the level of rates does not change our hedging philosophy.
Daniel: One of the best opportunities so far this year has been the consumer non-cyclical.
The opportunities that we have seen have not often been new assets, new strategies, or different geographies, but just being able to differentiate between different sectors.
This current environment is very specific and is probably short-lived but is giving rise to some very different dynamics.
With the consumer non-cyclical, there are very few worries with them. There are other sectors, such as entertainment, catering, etc. which are consumer discretionary that are very challenged. It is about being able to differentiate between different sectors.
Even within a country, the geographical diversification mix is changing. For example, your central London offices don’t look very interesting right now and may be challenged in the long-term.
"We haven’t changed our strategic asset allocation but have
been pickier within each of the sectors that we target."
If people do go back to their workplace, they might go back in a different way to previously, not five days a week. By comparison the out of town retail space or warehouses may not be that bad and could deliver cash.
There are some big shifts happening and the challenge is identifying what will be permanent and what will be short-term.
One other interesting aspect regarding property is of the case of central London offices. Whilst the sector may be challenged going forward, it may be that central London residential property makes a comeback with a more diverse city centre, such as in other major cities in Europe.
This conclusion will be very different in other countries where major city centres are much more diverse than in London.
It is challenging to apply a very broad-brush approach because the event is very specific, and each sector will react in a very different way.
We haven’t changed our strategic asset allocation but have been pickier within each of the sectors that we target.
