Improving Investment Results: Keep an Eye on Your Peers

Thursday, February 12th, 2015

Who doesn’t want to know how they compare to their peers?

From ‘keeping up with the Joneses’ to ‘I’m better than you,’ there are many ways of expressing this sentiment in everyday life.

Of course, insurers are known as long term, conservative investors who have less need for sentiments such as those.  Nonetheless, insurers are incessantly compared to peers by regulators, rating agencies and the press, to say the least.

The problem is that many of those peer comparisons are riddled with problems, starting with three important questions that need to be answered:

  • Do we have adequate data to make the comparison?
  • Are we comparing the correct information?
  • Are we comparing to the right peers?

We have viewed many different peer analyses that attempt to address these issues, and then expand the peer analysis to unnecessary levels of detail. This is undoubtedly due to the myriad of questions that hound peer group analysis, such as, “What about x characteristics, or y information, or z related data?”

At Strategic Asset Alliance, we have tackled these problems and developed a focused peer analysis to help answer a very specific question: “What can we do to improve investment results?”

In this incessant low rate environment, it is increasingly important to consider assets outside of traditional investment grade core fixed income to improve those results. But, we all know that stepping too far outside the bounds of propriety (as seen by the regulators and ratings agencies) is probably not a very good idea, no matter how compelling an asset class may appear to be.

But, simply comparing to competitors is not a very good idea, as many times those competitors are of significantly different size than your company.  And, there is no getting around the fact that rating agencies have a large company bias, coupled with the other fact that larger companies typically have more investment flexibility than smaller companies. (This should not, however, rule out inspecting the public filings of those large company competitors.)

With these issues in mind, we have established proprietary SAA Structured Peer Groups, using data provided by SNL Securities, which are grouped by asset range, within a similar business line focus.  Thus, Structured Peer Groups allow us to compare what are, in essence, ‘investment competitors,’ companies that may not even write business in your geographic area but do compete with you more directly in the investment marketplace. 

Within each Structured Peer Group, we focus on key indicators that might shed some light on the relative levels of investment risk being taken by companies similar in size and line of business.  These indicators are not designed to identify all kinds of investment risk – publicly available information is neither broad nor deep enough to allow such analyses without making spurious assumptions.  However, these indicators are designed to focus on the types of investment risk which is readily understandable from the data.  (Thus, we have excluded interest rate risk for this analysis due to lack of adequate data.)

Within the SAA Structured Peer Groups, we compare four major investment ratios and two major financial ratios, assigning peer companies into quartiles.  The investment ratios are:

1) BBB Bonds/Surplus – While BBB bonds are still part of the core fixed income portfolio, they do inhabit the bottom tier of investment grade.  With rates having fallen to historic lows and the shrewdness of corporate treasurers having risen to historic highs, many issuers have decided that they can operate better outside the financial constraints posed by ratings above BBB.  Thus, BBB’s have become a larger part of corporate bond indices and of insurer portfolios over time.  Nonetheless, they do cover a higher probability of loss than other ratings within investment grade, so understanding peer investment in this rating class is important.

2) Common Stock/Surplus – As common stock is marked to market and impact surplus immediately, the amount of surplus being risked is important and measure of market risk.

3) High Yield/Surplus – P/C and L/H companies play by different accounting rules when it comes to these bonds, which typically perform somewhere between investment grade bonds and common stock.  However, it is their imbedded credit risk which, should losses occur, impacts the bottom line and, concurrently, surplus.

4) Risky Assets/Surplus – Because insurers can creatively place some rather interesting investments in their portfolio and they can find their way onto Schedule BA, we have attempted to sum all Common Stock, Preferred Stock, High Yield and Schedule BA assets and compare to surplus.  This is an attempt to measure overall market risk (including credit risk) from these non-core fixed income assets versus surplus levels.

In addition, because insurers are levered institutions, they consider operating and financial leverage when deciding where to take risk.  With that in mind, we decided to include those two ratios in the peer comparison. 

You can see a preview of what these measures look like for your entire industry by choosing one of the following links.  However, please remember that this does not take into account the more appropriate peer analysis possible with a SAA Structured Peer Group.:

You may be wondering how your company compares within its SAA Structured Peer Group and you can indeed see this complimentary analysis on InsurerCIO by emailing us.

And, you may be interested in learning more at a session called, “Thinking Inside the Risky Bucket,” the session that completes our upcoming Insurer Investment Forum.

Peer group analysis is a good initial step in comparing to similar companies in similar lines of business.  By focusing on some key measures of how companies are taking on investment related risk, we can take the first step in answering the question, “What can we do to improve investment results?”

After all, “a journey of a thousand miles begins with a single step.”

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A Bad Year for Jed Clampett Means an Unpredictable New Year for You

Wednesday, January 14th, 2015

You remember Jed, don’t you?  The head of the once famous TV comedy of the 1960s, The Beverly Hillbillies?  Well, if you don’t, maybe you’ll remember this opening sequence:

Of course, Jed’s good fortune in the show’s opening was all about finding oil.

However, with oil prices having dropped like a rock in late 2014, we come into 2015 with trepidation and expectation at what this will mean for global economies, interest rates, financial markets, credit risk and, of course, geopolitical nastiness.

I’ve read quite a few summaries of ‘what to expect’ in this arena, but perhaps the best, cautiously reasoned summary comes from the Longbrake Letter, written by Bill Longbrake and published through the law firm of Barnett, Sivon & Natter.  You can easily access this Letter through our InsurerCIO website.

Bill puts the incredibly shrinking oil price in perspective as he describes the Investment Accelerator Cycle – with our current situation being excess supply created by previously high oil prices incenting more oil exploration and development.  Add to that slowing global growth in most developed economies and you get a supply/demand imbalance that must be met by quickly falling prices.

It matters not whether we are talking about oil or residential home prices, price is what gets adjusted such that supply and demand is eventually put into balance.

Bill calls OPEC’s decision to keep pumping oil despite lower prices as classic monopolist behavior (though OPEC is more an oligopoly than monopoly):  forgo short term profits to drive out higher cost producers in order to maximize profits in the long run.  (I can still hear my Econ 1 professor lecturing about that.)

Importantly, Bill notes the dynamics of the ‘Producers Lose-Consumers Win’ scenario that this creates.

Of course, who hasn’t heard that a drop in oil prices (gasoline prices at the pump) is like a tax cut for the consumer?  But, we are already starting to read about layoffs and decreased investment by oil producers.  The net impact, Bill estimates, will be about a positive 0.5% to US GDP.

Importantly, he notes the impact on leveraged loans and corporate bonds tied to the energy fields, quantifying the net negative impact of loss of inventory value used to finance operations at over $300 billion.  Not as large a loss as the housing bubble, but still quite material.

To the extent such debt is held at financial institutions, there is the potential for some financial contagion, depending upon the institution’s concentration in these types of credits.

This brings up the importance of going back to your investment manager with key questions such as:

What is our portfolio’s direct and indirect exposure to oil prices?  Specifically, which bonds and/or leveraged loans should we be most concerned about?  What would be a reasonable ‘stress test’ loss on such credits, assuming oil prices remain where they are, or assuming prices drop another $x per barrel?

The best managers will be able to do their best at quantifying this exposure for you –within a reasonable range.  The ‘less than best’ managers will get out their best ‘tap shoes’ and try to assuage any concerns.

Finally, Bill discusses the dichotomy of “Producing Countries Lose – Consuming Countries Win”

Here he notes that Japan and Europe would fall into the ‘win’ category, but one must watch how things play out.  Will the benefit of lower oil prices be a one time event for these economies that is offset by further downward pressure on prices (e.g. deflation)?

Of course, producing countries that lose include Venezuela and Russia (to which I would add several Middle East countries). 

In my opinion, if you want to watch one geopolitical hotspot it would be the former Soviet Union.  Of producing countries that lose with much lower oil prices, only Russia has nuclear weapons.  With their economy under pressure (with economic sanctions, lower oil prices, a plunging currency and raging inflation), the probability of civil unrest rises – even in an authoritarian state – and that would definitely be upsetting to all financial markets, to say the least.

Finally, Bill notes that falling oil prices do have many positive attributes for the global economy, but we should keep an eye on some negative consequences, which might include debt defaults, tighter financial conditions and deflation.

As you can see, Jed Clampett (or his banker, Mr. Drysdale) never had to deal with the current state of oil prices.  “Bubbling crude” and the geopolitical environment were different in the 1960s.

As 2015 begins, let’s hope the positives of lower oil prices far outweigh the negatives.

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What Would You Own If You Could Manipulate Markets?

Thursday, September 11th, 2014

That is not a rhetorical question.  Alas, there are those who can indeed manipulate financial markets at the stroke of a pen, the mention of a brief comment, or the utterance of a sigh.

Who, you may ask, can consistently do such a thing?

Warren Buffet?  Not really.  Even the wizard of Omaha is subject to seeing where Mr. Market prices securities before he can dream up his next move, which in turn moves a very small part of the market.

President Obama? Yes, but what he says or does could have unexpected and varying impacts on financial markets. Is Obamacare good or bad for markets?  We shall see, but its impact will undoubtedly vary depending upon the company, person, etc. Will declaring war on ISIS cause markets to fall or rise?  A case can be made on both sides of that question.

Big hedge funds, private equity players, algorithmic computer traders?  Yes, but usually only for a very small subset of the markets.

Of course, the granddaddy of all market manipulators would be the Chair of the Federal Reserve. He or she has direct, effective control of short term interest rates offered by the largest debtor in the history of the Universe (as far as we know). And, he or she can create money out of thin air with a press of computer key (QE).

With such incredible power, you probably would want to be very careful where you invested; not wanting to be seen as making decisions ostensibly in the public interest, while lining your own portfolio with profits. As, the most powerful economic figure in the world, you would be very careful what went into your portfolio, whether it was sitting in a ‘blind’ trust managed by others or not.

What investments did the last three Fed Chairs own? (And, please remember that, by law, Federal Reserve Governors cannot own the stock of banks, thrifts or primary dealers of US government bonds.)

Leading off our gallery of manipulators is, of course, “the Maestro” himself.  Alan Greenspan served as Fed Chair from 1987-2006, although subsequent events proved him a less than perfect Maestro.  He invested the bulk of his portfolio in US Treasuries.  Why?  He wanted to avoid stock market investments lest he be seen as having a conflict of interest. 

The second manipulator is the man nicknamed “Helicopter Ben,” since he said any possible deflation could be stopped by printing money.  And print money did he ever during multiple QE’s.  Ben Bernanke served from 2006-2014.  His largest investment holdings were two annuities (one fixed, the other variable) from the venerable TIAA-CREF and dating back to his days as an academic Princeton Tiger.  

Although a variable annuity may move with equity markets, holding onto two annuities from your retirement plan provider for years is not exactly a great way to play the markets you are manipulating.  It is more aggressive than holding Treasuries, but still a relatively conservative, passive approach.

Recently, our still brand new Fed Chair, Janet Yellen disclosed her holdings with her Nobel laureate husband George Akerlof.  The couple owns a mix of investments with individual stock holdings and a variety of mutual funds.

Have times changed for the Fed Chair: from a Treasury only philosophy of not wanting to be seen as having a conflict of interest to a full on equity portfolio. And the Chair is not alone, as her compadres on the Board of Governors also have various equity investments.

Meanwhile, the top market manipulator and her compadres ultimately report to the President, who has most of his portfolio in low yielding US Treasuries.

What would you own if you could manipulate markets?  The Chair of the Federal Reserve has answered that question, but is it the correct answer?

To paraphrase Henry Higgins in the play My Fair Lady, “Why can’t the Fed Chair invest more like a Maestro?”

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Inverting the Logic on Inversions

Thursday, July 31st, 2014

And now for something completely different…

Why tax inversions – the practice of a US company merging into a non-US company to lower/avoid income taxes – could ultimately produce different, better results for the economy.

First some interesting reactions and ideas:

From Andrew Ross Sorkin of the New York Times, a look at how Wall Street banks are profiting from advising companies on taking advantage of this tax maneuver.   We’re talking over $200 billion in fees…for Goldman Sachs alone…while these ‘too big to fail’ banks preach the importance of investing in America.

Let’s not forget that America (that’s we the taxpayers) bailed out those same banks who are now advising companies to merge and redomesticate for tax purposes to lesser taxing shores.

Meanwhile, the famous hedge fund investor, Stanley Druckenmiller, says the debate over inversions gives the U.S. a chance to debate tax policy from an investor’s perspective. He correctly notes that inversions have produced a windfall in capital gains for shareholders.  And, since shareholders ultimately benefit, they should see their taxes rise (via a capital gains or dividend income tax increase) to offset the lost tax revenues.

Of course, raising capital gains taxes on all investors just to offset inversions that benefit a few does seem a bit self-serving in favor of investors who benefit from inversions.  But, I suppose the venerable Mr. D believes he can ferret out those inversion candidates better than most.

Now, let’s put this discussion in perspective and provide a modest proposal:

First, Wall Street advising their clients to take advantage of loopholes in the tax code is as old as…the tax code.  One wonders if this dates back to one Babylonian advising another how to get around one of Hammurabi’s codes.  So, this is truly a ‘dog bites man’ story.

Second, Wall Street banks acting in their own self-interest is probably as old as, well, humans.  Have you heard any Wall Street CEO even say ‘thank you, fellow taxpayers, for supporting your local too big to fail bank?’

Meanwhile, Mr. D does say that inversions have raised talk of changes in the tax system.  So, why not consider something completely different?

How about treating corporations like people?  You know, people like you and me, who get to pay tax US tax on income earned anywhere – probably even Mars, if the government had its way.  So, invert away, Mr. and Ms. Corporation, but you will still be paying US income tax.

And, what of those who have already inverted?  Or, companies holding cash overseas because bringing it to the US would incur US income tax?  Work out a gradual payment plan…just like the government would do with any debtor…to get those taxes paid.

But, let’s treat corporations like people and tax universal income, only if this is specifically tied to lower corporate tax rates for all corporations – large, medium and small.  The net impact to Federal revenues would be zero, and, with a lower tax burden on all the Mr. and Ms. Corporations, we might even see a better uptick in economic activity.

So, under this modest, simplistic proposal, corporate tax rates go down, which may lead to improved economic results, and Wall Street banks have to find new ways to game the tax code.

But, they will always find new ways of doing that.  We should expect nothing less.

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Is Putting Investors First the Future of Finance? It Better Be

Tuesday, May 20th, 2014


Is Putting Investors First the Future of Finance? It Better Be

By Alton Cogert

Recently, the CFA Institute began an important new initiative called the Future of Finance.  It was the result of an important study that the Institute conducted earlier, and that we discussed in this blog back in November, 2013: “Whom Do You Trust? A Brewing Crisis in Investment Management.”

Basically, the Future of Finance consists of 50 ways to restore trust in the investment industry.  Why this initiative now?  That study showed that, even among institutional investors, 40% do not trust investment managers.  Of course, we must assume they do trust their existing managers, else those managers would be replaced.

However, the sight of investment professionals being considered near the bottom of the ‘whom do you trust’ list of occupations makes one ponder.  What could be the reasons?  Numerous examples of immoral if not illegal activities?  Unaligned incentives, also called the agency problem, where the manager and investor have different incentives?

What is the Future of Finance?

Well, the CFA Institute’s Future of Finance initiative focuses on six areas to tackle this problem:

-   Putting Investors First

–   Financial Knowledge

–   Transparency and Fairness

–   Retirement Security

–   Regulation and Enforcement

–   Safeguarding the System

Did you know that this month is Putting Investors First month?

I did not either, until I attended the CFA Annual Conference.  Of course, less than 2% of CFA’s attended, but that still meant nearly 2,000 got the message directly.

How Can You Put Investors First?

Putting Investors First includes:

-   Statement of Investor Rights

–   Asset Manager Code of Professional Conduct

–   Fee Structure Guide for Investors

–   Board assistance in the form of a self-assessment tool and best practices guide

We highly endorse these actions, but are deeply concerned that they have not been more quickly and forcefully adopted by the investment industry.

For example, there are many investment managers who are knowledgeable about investments for insurers, yet have not yet adopted the Asset Manager Code.

Also, with investments and the investment process becoming more and more complex, I wonder how many investment managers know that their clients fully (and I do mean fully) understand all salient aspects of an investment and how it impacts their portfolio.  You can find that imbedded in the Statement of Investor Rights.

The Principles of Investment Reporting

Of course, each of those six areas has their own details and investment professionals would do well to take all of them to heart.  One of my favorite details is the Principles of Investment Reporting.  Item four is: “Clear and transparent presentation of investment risks and results.”

If that is true in all instances, why do Strategic Asset Alliance and InsurerCIO spend so much time in crafting investment reports that focus on those key risks and results, while many manager reports may not be similarly focused?

One possible answer:  Manager reports focus on how they see the portfolio from their vantage. Those reports help them do their job.  However, they may not always focus on the key issues that are unique for your insurance company.

The Future is Up to You

Nevertheless, the most important point remains.  It is incumbent upon all investment professionals to internalize the key activities and responsibilities inherent in the Future of Finance initiative.  And, it is even more important that investors require such compliance.

The Future of Finance is really up to all of us.

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Public Enemy #1 of Good Investment Decisions: Groupthink

Tuesday, March 25th, 2014


Public Enemy #1 of Good Investment Decisions: Groupthink

By Alton Cogert

Virtually no important strategic investment decisions are decided by one individual at an insurer.  Of course, one person may be ultimately responsible for performance, process, etc.  But, mostly key strategic decisions are made in group settings.  This is even more likely at external investment managers.

At this month’s Insurer Investment Forum XIV, I discussed several issues, including cognitive limitations and biases that cloud our ability to make good (investment) decisions.  I discussed several biases found in the behavioral finance literature that generally apply to an individual decision maker. I also mentioned the largest cognitive limitation and bias for groups of decision makers:  Groupthink.

Groupthink is a psychological phenomenon that occurs within a group of people, in which the desire for harmony or conformity in the group results in an incorrect or less desirable outcome. Group members try to minimize conflict and reach a consensus decision without critical evaluation of alternative ideas or viewpoints, and by isolating themselves from outside influences.

Read that definition twice and you will undoubtedly be able to think of numerous instances where Groupthink has been at work.  I worry about that at just about every board or investment committee that I attend.


Many times, of course, general agreement is OK.  But one cannot help but wonder if general agreement may be getting high jacked by Groupthink.

How to guard against Groupthink?  Here are the activities suggested by Irving Janis in his book “Groupthink.” , with my initial thoughts in parenthesis.

1. Leaders should assign each member the role of “critical evaluator”. This allows each member to freely air objections and doubts.

(This rarely occurs.)

2. Leaders should not express an opinion when assigning a task to a group.

(This is important, but occasionally forgotten.)

3. Leaders should absent themselves from many of the group meetings to avoid excessively influencing the outcome.

(Done occasionally, as when a CEO leaves a Board meeting to allow for discussion amongst Board members only.)

4. The organization should set up several independent groups, working on the same problem.

(I have never seen this done at an Investment Committee in twenty years as an investment consultant.  If a separate group is set up, the problem is not also assigned to another group.)

5. All effective alternatives should be examined.

(This is more difficult than it sounds, but Boards and Committees do try to do this.)

6. Each member should discuss the group’s ideas with trusted people outside of the group.

(This can occur informally.)

7. The group should invite outside experts into meetings. Group members should be allowed to discuss with and question the outside experts.

(That is where our firm comes in, and that is one of the ways Boards and Committees utilize our firm.)

8. At least one group member should be assigned the role of “devil’s advocate.” This should be a different person for each meeting.

(I worked at a company where one group member was ALWAYS the “devil’s advocate” due to his nature, not because he was formally assigned as one.  That “devil’s advocate” soon became, shall we say, less than respected by the group.)

SAA does not provide consulting for improved group dynamics, but we are concerned that senior management teams, Investment Committees and Boards of Directors are making the right decisions.  We focus on improving an insurer’s investment process, but this can only occur with a solid group decision making process.

Insurance Regulators to Add Russian Sanctions?

Tuesday, March 25th, 2014


Insurance Regulators to Add Russian Sanctions?

By Alton Cogert

Notice there is a question mark after that headline.

“How preposterous!” you might say, “State departments of insurance have no power to practice foreign diplomacy.  Besides, what kind of sanctions could they possible impose on Russia.”

Well, with Russia and the West adding to their list of sanctions, don’t be surprised if the insurance regulators pile on.

Why? It has been done before.  Not against investments in companies doing business with Russia, but with Iran.

Enjoy this link to an article published in 2010.  The California Insurance Commissioner, preparing a run for governor, decided to practice foreign diplomacy.  Most insurers abided with the ruling, while some of the largest insurers and trade organizations railed against the action.  The Commissioner published a list of 296 insurers doing business in the Golden State who agreed to comply.  For them, as for the larger non-compliant insurers, it was a small issue blown out of proportion.  However, for the 296 it was easier to switch than fight.

Would Dave Jones, no relation to the late Monkees member, but current California Commissioner, take his own last train to Clarksville and follow in his predecessors’ footsteps?

It is doubtful.  Please remember that the previous Commissioner Poizner was trying to differentiate himself in a gubernatorial election year, while Democrat Jones is not about to challenge his boss, Jerry Brown, running for his fourth and final cumulative term.

However, what of another commissioner?  Although there only twelve elected commissioners, some may consider the office a jumping point for higher office.  To the extent politics is involved, we may very well see a state commissioner or, perish the thought, the Federal Insurance Office, decide to waive the anti-Russian flag.

Is this just silly, peripheral nonsense?

Maybe not, as we’ve already seen the Russian billionaire owner of the Brooklyn Nets consider re-domiciling his NBA team to Moscow.   Stranger things may be afoot.

In this world of mutually assured sanctions,  don’t be surprised if a ban on a list of companies doing business with Russia is proposed for insurers,  or even adopted by other institutional investors (especially politically sensitive pension plans).

Spasibo, comrades.

Which Strategic Asset Allocation Model is Best?

Monday, October 21st, 2013

We have all heard that choosing the asset allocation for your insurer will basically define your investment results. In other words, strategic asset allocation explains about 90% of the variance in performance.

Tactical asset allocation can add value, but is difficult to achieve in the long run for a host of reasons. These include transaction costs, taxes and issues in the ability of managers to add material value over passive benchmarks over long periods of time. Quite frankly, common sense dictates that the more efficient the market for the asset class, the more difficult it will be to add value with tactical asset allocation.

Thus, we are back to starting our discussion about the importance of asset allocation with strategic asset allocation

But, where should we start?

Most practitioners will reach for their Markowitz efficient frontier models (or MPT, Modern Portfolio Theory), plug in historical values for return, standard deviation and correlation amongst asset classes, beginning the discussion in that manner.

Those same practitioners, if prompted, may point to the inadequacy of using historical values and suggest more reasonable expected returns, standard deviations and correlations. Assuming these projected values are reasonable, we are still left with some of the major issues in MPT, including:

  • Asset returns are normally distributed. Alas, they are not. Even something that may seem to be normally distributed, like US equity returns are not. Upon further inspection, a log normal distribution (with thicker ‘tails’ on both the far upside and far downside) seems to do a better job of approximating historical returns. And even that can understate strong downward moves.
  • Correlations are fixed and do not change. Alas, that is not the case. There is actually a web site that helps prove the point. Just focus on a simple correlation between US Large Cap (e.g. S&P 500) and the Barclays’ Aggregate Bond Index, and you will see correlations go from .05 to -.05 to 0 to .18, depending upon the time period chosen. A big difference? Not much by itself, but when combined into the MPT model, especially with other assets, it can make a big difference.
  • All investors are rational and risk-averse. In other words, all investors will want to be on the efficient frontier (e.g. highest return per unit of risk) at all times. I don’t know about you, but I have yet to meet a completely rational human being. Importantly, we see ‘irrational exuberance’ to some degree in many situations, especially the financial markets.
  • If all investors followed MPT’s recommendations, it would probably invalidate some of the assumptions in the model. In other words, if everyone used MPT because it provided the ‘best’ asset allocation mix, it would then not provide the ‘best’ asset allocation mix. In other words, model inputs change if everyone follows MPT.

There have arisen changes to the MPT that answer some of these major issues.

For example, post-modern MPT uses non-normal distributions. And, with the Black-Litterman model, the investor is required to state how his or her assumptions about expected returns differ from the market. And, then the investor must state his degree of confidence in the alternative assumptions.

Also, another look at strategic asset allocation is provided by an approach that uses regime changes in market turbulence, economic growth and inflation to forecast expected asset returns. Determine the regime and you will get a better idea of returns, risks and correlations. There is much more work to be done on this approach, although it does move a step closer to a tactical asset allocation approach than a strategic one.

Of course, the major problem with 100% of these models is the nature of the beast: Financial market returns, risk and correlations are all somehow related to that which has occurred in the past. This works with things that do not change and only have to be ‘discovered,’ such as we find in traditional physics (less so in quantum physics), chemistry and biology.

However, how many of us remember the last time central banks played such a major role in world economies and in the financial markets? I don’t see any hands being raised, so I think you see what I mean.

We are operating in an environment where all the fancy models in the world may not be a very close analogue to what we may see going forward…in addition to the major issues and approaches in those models, already noted. Thus, we must be careful to shy away from ‘physics envy.’

With that in mind, we must think creatively when it comes to strategic asset allocation, and that probably starts with a simple mindset.

What are the reasonable returns we can expect on a given asset class over the next 3-5 years (assuming that is your relevant timeframe)? How might correlations change over that time frame (we can perform a sensitivity analysis to see if and how much that might matter)? And, really, what is the ‘worst case’ returns one can expect in a given asset class performance, given what we know about today?

These are very, very difficult questions that should lead to very productive discussions with your investment consultant and investment manager.

Are you ready for some Fumbling?

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I Miss the Fiscal Cliff

Wednesday, October 16th, 2013

Remember the good old days…of last year?

Remember, when the financial press warned about the US economy going over the ‘fiscal cliff’, because our so-called ‘leaders’ in D.C could not stop a fiscal contraction that would hurt a still limping economy?

Although the academically inclined chair of the Federal Reserve, Mr. Bernanke, mentioned the phrase, it really brings to mind a battle between two hard charging racers, heading for their potential demise…as brought to life in this video :

The result of this fiscal cliff wrangling was modifications to the income tax code plus another new word added to our collective vocabulary: ‘sequestration’. Eventually, then Treasury Secretary Geithner added the country’s debt limit into the stew of fiscal issues, and another ‘crisis’ was born.

As you read this, perhaps the D.C. Fumblers (that is a much better name for their hometown football team than Redskins) will have ‘solved’ the budget and debt limit issues that, once again, threaten the U.S. economy, financial markets, and, more importantly, the preeminence of the US dollar as a global reserve currency.

Perhaps not.

But, more likely than not, the Fumblers will trade a disastrous result today for the potential of a disastrous result to be named later (in just a few months). Another bad Fumblers trade.

The point is that we, as sentient humans, should not be fooled into using simplistic shorthand like fiscal cliff, sequestration or even the previous word d’jour,’ tapering.’ By falling back on this shorthand, we are conning ourselves into thinking that these problems are two sided or easily explainable. They are not.

Coke or Pepsi?

Left or Right?

Tapering Now or Later?

Fiscal Cliff or Not?

Sequestration or Not?

We must look behind the issues and apply reason to develop the vast array of choices that are open to us. And, most importantly, consider the intended as well as unintended consequences from those choices.

As for our portfolios, it is truly difficult to position them for all possible Fumbler scenarios as we approach what used to be called the fiscal cliff.

Some ‘experts’ tell us that markets have not fully discounted the probability of US default, or of the impact of a continuing government ‘shutdown’ on GDP. Others say that the markets already discount such probability efficiently (in concert with the ideas of Nobel Prize winner and efficient markets proponent Eugene Fama).

So, we are left to doing what is best based upon the unique requirements and risk appetites of our clients. In other words, no material change in operating procedure.

Meanwhile, one thing can be sure at this point in the political cycle. The D.C. Fumblers will continue to be true to their name.

The markets will now have to discount the possibility that watching the Fumblers deal with another ‘crisis’ will become a regular event, with increasing frequency….

Are you ready for some Fumbling?

Return to “From the Northwest Quadrant”

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Hank at the Brink…Again and Again

Tuesday, September 24th, 2013

“I didn’t have to have long debates with President Bush about how bad the harm to the economy would be if the financial system went down. He had a good feel and he understood markets.”

That’s former U.S. Treasury Secretary Henry Paulson explaining his relationship with former President George W. Bush during the financial crises, in Bloomberg Businessweek’s initial foray into filmmaking – basically a visually annotated interview with Paulson.

The movie is only available on Netflix, much like one of my own personal favorites, House of Cards, the multi-episode fictional story of slimy, unethical practices in the day-to-day maneuverings in Washington, D.C. Most people who have seen it can hardly wait for Season 2 later this year.

Like House of Cards, Hank Five Years from the Brink, is about slimy, unethical practices, but this time in the financial industry. Unlike House of Cards, it spares most all of those at the top from criticism, while providing an explanation that ostensibly is reasonable, but is filled with holes. Most people who see this movie will not want to see a financial crisis 2.

In Paulson’s defense, he actually does a good job of initially answering a difficult question: Why let Lehman Brothers go under and not AIG?

His answer: The Treasury could make a loan to AIG with viable insurance subsidiaries as collateral, while Lehman had no such similar subsidiaries. True, but…

A side benefit: His former employer, Goldman Sachs, had some rather complex and hidden dealings with AIG. Some of which could be said to have forced the hand of then NY Fed president Tim Geithner to make the big banks whole on CDS from AIG. Other dealings are probably still open to interpretation ( In any event, for Paulson to not even mention this in passing is akin to the famous line in a much better movie, the Wizard of Oz,: “pay no attention to the man behind the curtain.”

Another “pay no attention” moment in the movie is when Paulson says that while he, Bernanke and Geithner were trying to come up with a solution for the Lehman mess, ex-Goldman buddy and then head of Merrill Lynch John Thain struck a deal to have Bank of America purchase ML. It is hard to believe that “the man behind the curtain” had nothing to do with that acquisition.

Paulson also does a poor job of explaining why the use of the hastily approved TARP money changed almost overnight, from purchasing bad assets from banks to providing capital to banks.

As I remember, one reason was that the government said it was so difficult to value those bad assets. Of course, this belied the reasoning behind an earlier, successful bank “bailout” program run via the Resolution Trust Corporation in the 1980s. But, Paulson does not mention that publicly stated reason. Oops.

And, of course, Paulson only raves about his close relationship with Fed Chair Bernanke and NY Fed President Geithner, saying they worked very closely together. However, this fails to account for the importance of an independent central bank. I guess Hank may not have paid full attention in his economics courses at Dartmouth.

What about the Special Inspector General of TARP? What was Hank’s relationship with this Congressionally mandated office, designed to monitor and audit the TARP program? In the movie, it was as if SIGTARP never existed. Of course, former SIGTARP head Neil Barofsky would probably agree with that assessment, as outlined in his well written book, “Bailout: An Inside Account of How Washington Abandoned Main Street While Rescuing Wall Street.” (amazon link here).

At the end, Paulson says he ‘did’ this movie because he does not want to see a replay of what happened. Of course, he says that after he unequivocally states that there WILL be another market meltdown. Perhaps, a better title for this Netflix only stream should have been, “Hank at the Brink…Again and Again.”

Although I am not a movie critic, please allow me to briefly remember the two great movie critics, Siskel and Ebert, and give Bloomberg Films a ‘thumbs up’ for trying to present a complicated subject. And give ‘Hank at the Brink’, ‘two thumbs down’ for pandering away from the truth.

Until next time, the balcony is closed.

Return to “From the Northwest Quadrant”

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From the Northwest Quadrant. We chose that name for this blog for its multiple meanings and to highlight a new beginning. Investment professionals are all familiar with the preference for building portfolios that are in the Northwest Quadrant of the risk/reward graph — improved return with lower risk. And, those of you who know Strategic Asset Alliance (SAA) know that our headquarters are located in the Northwest Quadrant of the lower 48 United States - Bellingham, WA. Of course, those of you who know SAA also know that our approach to improving the investment process, and with it the financial results, of our insurer clients goes well beyond the typical efficient frontier risk/reward graphing so familiar to pensions, endowments, foundations and others. And, that is the main purpose of this blog. To provide an ongoing commentary on how INSURERS can go beyond the business as usual approach to investments and improve their financial results, with the Northwest Quadrant as a point of departure. Your comments are most welcome on any entry in this blog. And, simultaneously with the introduction of this blog, SAA is introducing the Insurer Investment Forum Online - an opportunity to enjoy an ongoing Q&A with your peers and other experts on the investment process for insurers. Like Lewis and Clark, we stand in the Northwest Quadrant together ready to forge a new approach, but this time to improve the insurance invesment process for insurers. I hope you will join me on this adventure.




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