Saturday, 29 April 2017
Last updated 18 hours ago
Mar 31 2015 | 6:48am ET
By Andrew Plevin and Philip Siller
Co-CEOs, BroadRiver Asset Management
Investors are languishing in a yield-starved, low-interest rate environment, looking for ways to capture yield without taking on increased risk. The headwinds of the global flight to quality, efficient capital markets, correlated asset classes and falling commodity prices not only make it difficult to search out alternatives to bonds, but also potentially threaten the viability of existing positions.
Liability awareness among institutional asset managers has always been high. Because of the low rate environment, institutional managers must monitor more closely those allocations that are earmarked to meet cash requirements, so that the sustainability of their portfolios is maintained. What today's environment may demand, even for those entities not adopting liability-driven strategies, is a risk analysis that is more obligation focused and less asset benchmarked. The key question is: How will the overall portfolio perform relative to actuarial assumptions or spending requirements? How does each asset class or portfolio contribute to those objectives?
One response to the challenge of the low interest rate environment has been to reconsider risks that were previously excluded as too dangerous. Institutional fixed income managers are allocating to high-yield debt, mid-market asset-based lending and emerging market debt in an effort to achieve yield. While there may be perceived comfort in the fact that “everyone else is doing it too,” the risks of strategies that burned investors in the not too distant past – e.g. relaxed covenants, moving down the capital structure, leverage on riskier assets and lower credit quality – are now compounded by a crowded field, vying for the same assets, for the same most talented managers, and for exit strategies that are highly correlated.
There are, however, strategies involving less conventional assets that may capture yield without taking on increased risk. Among the strategies receiving increased attention is private credit – and longevity risk in particular.
Today, longevity risk represents an increasingly desirable risk profile. Having been studied and quantified systematically for over a century by governments, pension managers, demographers and others, longevity risk is characterized by predictability and non-correlation to the financial markets.
The asset class and its potential benefits are gaining wider acceptance among institutions, including entities as diverse as Berkshire-Hathaway, Apollo, University of Michigan, New Zealand Superannuation Fund, Blackstone and the Canada Pension Plan Investment Board. Many investors view longevity risk as investment-grade fixed-income – i.e. risk that when properly accessed can match the liabilities investors depend on their portfolios to fund. Longevity risk pools behave predictably and are virtually impervious to market movements. Accordingly, when viewed as a form of fixed income, longevity risk provides the investor with compelling non-correlated, low-volatility returns and reliable cash flow. The trade-off may be reduced marketability. And, unlike most of its alternative peers, longevity risk sits at the top of the capital structure of investment grade insurance companies.
On the consumer side, changing demographics and the acute demand for yield have created a beneficial environment for consumers looking to exchange financial assets they often no longer require, for value well beyond “par.” For example, life insurance policyholders whose needs change can monetize an unneeded financial asset and redeploy the proceeds more effectively. This confluence has created an investment opportunity for institutional managers and consultants with the capacity to analyze this value proposition.
Investors supporting this market have been rewarded as well. The market has evolved over the past few years, but is still in its nascent stages in terms of institutional adoption and acceptance. There are similarities to the emergence of the private equity industry, where only a few iconoclastic, open-minded institutions initially adopted the investments. And like PE, where investors ultimately realized the tremendous benefits for higher returns and diversification against public markets, private credit and longevity risk will also soon become broadly accepted for their value.
The raw data underpinning longevity risk is widely available. However, few managers in this space have met their stated return, volatility or cash flow objectives, despite persistent selection of assets that, on their face, should produce the expected outcome (Granieri, 2014). The standard is: Have the survival outcomes matched the predictions over time? Partnering with an asset manager that has realized the expected gains – as opposed to mark-to-market results – will pay surprising dividends for those willing to wade in.
Andrew Plevin and Philip Siller are co-CEOs and founding Principals of BroadRiver Asset Management, L.P., and both have played key roles in developing the company’s strategic plan, investment strategies, and related commercial initiatives. BroadRiver specializes in the management of fixed income alternative investments, including private credit and other assets that provide compelling risk-adjusted returns.