JUN 8 – 10, 2015
Title Slide
Introduction
to
Captive Investments
www.bermudacaptive.bm
Introduction to Captive Investments
Speakers:
•
Brad Komenda, Vice President and Portfolio Manager, Pioneer Investments
•
Andrew Baron, CFA, Head of Group Fixed Income
Butterfield Asset Management
•
Colleen McHugh, Corporate Investment Adviser, Vice President, Barclays
Wealth & Investment Management
•
Robert Steinhoff, CFA, Investment Manager, Clarien Investments Limited
Moderator:
•
Carl Terzer, Principal, CapVisor Associates, LLC
Introduction to Captive Investments
Agenda
– Investment Plan Design
– Strategic Asset Allocation
– Tactical Plan implementation
– Monitoring, Reviewing and updating Captive Investment
Programs
Introduction to Captive Investments
• Investment Plan Design
– Investment Planning Elements
• Self assessment
– Business objectives
– Investment objectives
– Risk tolerance
– Regulatory requirements
– Accounting considerations
• Investment Policy Statement (IPS)
Introduction to Captive Investments
Investment Objectives
The Continuum
Income Maximization
Insurers
Liquidity
Total Return
Others
Surplus
Reserves
Insurance Portfolio Segmentation:
Liquidity, Reserves and Surplus
Introduction to Captive Investments
Defining Investment Program Risk
• Traditional investment measure:
– Standard deviation
• Practical investment measures
– Losing money, i.e. safety of principal
– Not producing a targeted level of income
– Not having sufficient liquidity to pay claims
• Other insurance operational measures
– Failing to preserve or attain an AM Best rating
– Not growing surplus at desired rate
– Underperforming competitors
Introduction to Captive Investments
Risk Tolerance
Must recognize the existence of market risks in the investment portfolio
Should also make clear what the priorities are in terms of:
•
•
•
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Volatility (can range between “don’t care” and “Low”
Liquidity
Asset Quality
Diversification
Within this section, some mention can be given to the following other items:
•
•
•
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Any specified and regular liquidity needs
The Time Horizon of the investment portfolio (nearly always “long)
The existence of taxes, whether things like withholding tax should be avoided, the
Captive files as 953d, no Canadian Source Income, etc
Other unique circumstances (green, ethical, etc)
Introduction to Captive Investments
The Basics
Every Investment Policy Statement should have these building blocks:
1.
Purpose Statement/Introduction/Overview
2.
Portfolio Goals and Objectives
3.
Definition of Duties
4.
Investment Strategy and Asset Allocation
5.
Liquidity and Collateral Considerations
6.
Monitoring and Review Procedures
7.
Investment Limitations
Introduction to Captive Investments
At a minimum, each of the relevant parties that has some responsibility for the IPS should be
identified
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The Board of the Captive
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Has ultimate Fiduciary responsibility for the Captive company
•
If there are employees of the Captive Manager on the Board of the company,
they should know and recognize that they have a fiduciary responsibility in
this regard.
•
Should state whether monitoring the compliance to the IPS is the
responsibility of an Investment Committee or the Board
•
Investment Committee
•
Common in Captive governance, but not required
•
Usually responsible for recommending investment strategies, service
providers, brokers, custodians, etc to the full Board
•
•
•
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Investment Managers
Investment Consultants
Custodian
Actuarial provider – may have an effect on Investment Policy
Introduction to Captive Investments
The Importance of Investment Philosophy
Items that can be covered include:
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Whether costs are important
•
Whether inflation is a concern
•
Whether any contrarian views are desired
•
The purpose of inclusion of Alternative asset classes
•
Whether Active Management is desired or if there is a belief that an active
manager can add value
•
Whether any tactical shifts in asset allocation are going to be employed and
who is responsible for those decisions
•
Whether equities should have any inherent size bias (small, medium, largecap
•
Whether equities should any kind of style tilt (Value, dividends, etc)
Introduction to Captive Investments
Step 1 - Define Allowable Asset Classes
• “Equities” and “Bonds” is not an asset allocation
• Specifically set the type of assets that are allowable, unless you want a “go
anywhere” global manager
• Set a strategic allocation that makes sense in the context of the objectives of
the Captive – attempt to incorporate a forward Capital Markets assumption
• Be Realistic
• Set allowable ranges for the strategic or tactical allocation – this avoids the
possibility of getting over-emotional and potentially acting without an
Investment Committee vote
Introduction to Captive Investments
Strategic Asset Allocation
Introduction to Captive Investments
Terminology
Strategic Asset Allocation
• Intermediate to long term horizon typically 3-5 yrs. Measured in “business
•
Utilizes underwriting, claims, expected return projections
•
Incorporates customized risk and return measures
•
Governed by broad tax, statutory, and company- specific guidelines
•
Defines range of allocations
cycles”
Tactical Asset Allocation
•
Short to intermediate-term horizon
– Typically 3-18 months measured in weeks, months & quarter
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Utilizes actual underwriting results
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Incorporates current capital market pricing and relative valuations
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Governed by “temporary” modifications to portfolio based on market conditions
•
Defines specific allocation
Introduction to Captive Investments
Strategic Asset Allocation
Determinants of long term investment results
Sources: Ibbotson and Kaplan entitled "Does Asset Allocation Policy Explain 40%, 90% or 100% of Performance?" (2000).
Introduction to Captive Investments
Risk and Reward
Captive
Portfolio
Optimizati
on using
Efficient
Frontier
Analysis
90% Core FI;
10% S&P 500
75% Core FI &
25% S&P 500
Return
Core Fixed Income
Int. Gov. Credit
“Unoptimized”
Client Portfolio
100% US Govt.
Risk
• Efficient Frontier line represents the best possible risk/reward portfolio combinations available in
the marketplace
• Captives investment portfolios should lie on the efficient frontier to improve performance within
the same risk reward characteristics, i.e. increasing return at the same risk level (up arrow) or
reducing portfolio risk for the same return (left arrow)
Introduction to Captive Investments
10 year Asset Class Correlation Matrix
Introduction to Captive Investments
Strategic Asset Classes
(lower correlation)
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US bonds
•
High Yield bonds
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Convertible bonds
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US equities
•
International equities
•
Emerging market bonds/equities
•
Commodities, REITs, MPLS
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Hedge Funds
•
Private equity, mezzanine debt
Introduction to Captive Investments
Tactical Plan Implementation
Introduction to Captive Investments
Tactical Asset Classes
Fixed Income (Bonds)
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Treasuries
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Corporate Bonds
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Asset Backed Securities
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Mortgage backed securities
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Municipals, etc.
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High Yield
Equities (Stocks)
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Large Cap
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Mid Cap
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Small Cap
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Growth vs Value
•
Country/industry
Introduction to Captive Investments
Security Level Risks- Bonds
•
Credit
– Downgrade
– Default
•
Interest rate (Duration)
•
Liquidity
•
Inflation
•
Prepayment
•
Reinvestment
•
Convexity
•
Currency
Introduction to Captive Investments
Bond Market Mechanics
Interest Rates and Prices
Interest
Rates
Bond
Prices
Interest
Rates
Bond
Prices
Introduction to Captive Investments
Duration
Defined: a measurement of the portfolio’s sensitivity to interest rate
changes that approximates the % change in portfolio market value for a
given % rate change
Duration
Portfolio Duration = 3.5 years
1%
Interest Rate Changes
1%
3.5%
Portfolio Market Value Changes
3.5%
Introduction to Captive Investments
Investment Manager Style Risks
Equities- price volatility
Tactical
•
capitalization
•
liquidity
•
sector
Strategic
•
geographic
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political
•
geographic
Bonds–income volatility
• Duration
• Yield curve
• Sector
• Security
Introduction to Captive Investments
Bond Manager’s Style Risks
Strategy Toolbox
Duration
Security
Management
Selection
Yield Curve
Probability of Success
Potential Reward
Sector Rotation
Introduction to Captive Investments
Manager Selection Criterion
–
Philosophy
• “Total Return” or “Yield
Maximization”
• Active, passive or blended
management
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Process
• Top down or bottom up
• Alpha attribution: duration, yield
curve, sector, security selection
• Style analysis
• Tax efficiency
–
Performance
• MPT Statistical assessment
(Risk-adjusted return analysis)
• After-tax performance
• Adherence to guidelines
• Universe comparison
–
Personnel
• Insurance asset management
experience
• Insurance regulatory, tax and
accounting expertise
• Insurance Accounting and
reporting capabilities
–
Client-specific criteria
• Execution of policy objective &
adherence to guidelines and
regulations
• Fees/Value for service
• Portfolio tax liability
management
• Client service and other
administrative responsibilities
• Accounting & Reporting efficacy
• Overall relationship efficiency
Introduction to Captive Investments
Rolling Period Nominal
Returns
Introduction to Captive Investments
Nominal
Vs. RiskAdjusted
Returns
Introduction to Captive Investments
Monitoring, Reviewing and Updating Captive
Investment Programs
Introduction to Captive Investments
Annual Program Review
• Incorporate changes in:
– Operating conditions- underwriting, claims,
premiums, reinsurance, fronting, etc.
– Risk tolerance or investment objectives
– Captive growth expectations, etc.
• Review and modify planning documentation
– IPS/guideline or asset allocation changes
– Rebalancing rules
– Benchmarks, etc.
• Evaluation of manager performance
• Evaluation of overall program efficacy
Introduction to Captive Investments
Evolving Strategic Asset Allocation
New/Small Captive
Cash
25%
Advanced Captive
Cash
5%
Equities
10%
Investment Grade
Bonds
75%
Mature Captive
Cash
5%
A lt. Investments
10%
Investment Grade
Bonds
85%
Equities
25%
B o nds
50%
High Yield
10%
30