The post-Covid-19 business model continues to change, and this is especially evident in investing. Where companies should focus when looking at the asset behaviour for the ALM of the company, is a particularly pressing topic, says Bob Tyley, Group ALM Senior Manager, Legal & General Insurance.
In a recently released Clear Path Analysis report, Insurance Asset Management - Europe 2022, several market experts from insurance groups including Just Group, Phoenix Group, and New Re, explore issues around rebuilding and growing in the post-pandemic business environment.
“In my lifetime, I have listed six crashes, all bringing
with them various types of behaviours.”
“What was surprising about the market behaviour was the fact that we had a market crash – [it] should not have been a surprise,” Tyley explains about the markets during the height of the pandemic. “We get a lot of market crashes so from a long-term investor’s perspective we should be very aware of it. Britain seems to act on a one crash per decade basis, a statement that was written in the 1800s, so market crashes are common,” he said.
Tyley referenced the ‘big’ crashes that occur on a roughly once per century basis; Tulip Mania, South Sea Bubble, and the Great Depression, which he said, were all major changes in asset market behaviour.
“In my lifetime, I have listed six crashes, all bringing with them various types of behaviours as well as various similarities,” he said. “Looking at these crashes, I have noted how significant they were based on some of the conversation that went on at the time. Apparently, we had 17 sigma crashes in 1987 and 25 standard deviation events for the global financial crisis.”
Tyley said that his understanding of 17 sigma from a normal distribution, is that it likely wouldn’t happen in the lifetime of the universe. “What this tells us is that the models themselves may not be wrong, but they are not being used in the right way.”
Tyley said that if the market was not surprised that there was a crash, are we surprised that there was a pandemic? If we were, we shouldn’t have been.
“Just six years before, we had a [Willis Towers Watson] survey that showed that the pandemic risk was the number one risk that the insurance industry was worried about,” he said. “A few years later we had a report from Swiss Re highlighting the fact that these things were going to be happening more frequently and would be more severe. We had another report that stated we needed to prepare for these events, for national security and economic reasons.”
“Only high yield and emerging markets have more potential to compress,
however they may have some more macro issues to deal with.”
Current worries in the market are largely back to pre-pandemic fears of cyber and geopolitics - but inflation is also high on the list.
Tyley stated that there were massive swings in 2020 – 2021 within relatively short time scales, particularly for the long-term investment and the illiquid types of investment, which represented the opportunities in the credit markets. “Only high yield and emerging markets have more potential to compress, however they may have some more macro issues to deal with, still coming from the virus,” he said. Tyley added that interest rates didn’t follow equities back up in 2020 because of the huge fiscal and monetary stimulus they received. “However, in 2022, we witnessed this recovery in two phases. One due to the expectation that this stimulus is going to be unwound from the monetary side, and secondly inflation.”
He stated that inflation has been let out of its cage, which was something that the industry had been wanting for the last ten years. “It is now back with a vengeance. The big question is whether this is transitory or structural, and the answer to this could be important in what we do with our asset allocations.”
According to the UK’s Office of National Statistics, The Consumer Prices Index including owner occupiers' housing costs (CPIH) rose by 7.9% in the 12 months to May 2022, up from 7.8% in April, which was a 40-year high.
Even from an ALM perspective, Tyley added, one would think that interest rates are one of the most important things to be focused on. “It’s because we know how to do interest rate ALM, and it shouldn’t be much of a surprise anymore. We know that we have to make decisions as to whether we are hedging economic, accounting, regulatory or liquidity issues,” he said. “We know that there are limitations and what these limitations are. Although the market moves might be a surprise, ALM on this should be well known.”
“We are hearing about moving assets out of
government bonds and into these illiquid assets.”
With inflation going back up, the market now has rate rises as a potential negative issue that needs to be thought about. This could include some of those trade-offs that made predictions on rates being down the major issue that has to be re-examined because of a rates up world.
“In terms of factors that are perhaps more interesting from a structural perspective, one would be collateral management. We are hearing about moving assets out of government bonds and into these illiquid assets,” he said. “This means that we have less government bonds and that we might be needing to use more derivatives to manage some of these risks, whether it is interest rate mis-matched risks, or foreign exchange risks that are coming from overseas investment.”
It means that the market has been reducing its pile of collateral at a time when potential demands for it are going up. “Having a stronger focus on collateral and liquidity management is probably one of the stories coming out of the impact of this environment, given the current trends that we are seeing in asset management.”
