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The Actuary The magazine of the Institute & Faculty of Actuaries

Letters: Losing the plot

Kent Sandom asks if actuaries have lost the plot in investment management (Letters, December 2007). Yes. They lost it when modern regulations were introduced requiring the valuation of assets that support long-term liabilities to be on a basis to give comfort to people familiar only with deposit accounts and market prices. I like his sentence: “The valuation can be only a hypothetical exercise, while any switch in investments becomes a recorded and meaningful event.” Indeed, the asset sold will have realised less than the mid-market price and the one bought will have cost more. The distortion could be more pronounced where a very large holding is involved, as the sale may well push the price down and the purchase push it up. Add to this the euphoria and despair that influences daily market prices, involving a very small percentage of the issued capital, and their relevance in relation to the long-term liabilities is surely hypothetical. Forced selling at the wrong time can be avoided only by getting the cash flow right for the whole fund, which means choosing assets by type and term to match the outgo projected insofar as is possible. Invest too short and you miss out on the advantages available only to those that can commit for longer and the benefits to the client then cost more. Another hypothesis may also be usefully posed. Imagine the Stock Exchange is to close, never to open again. The investments would certainly not become worthless. The rights of investors are set out in their stock and share certificates and can be valued by reference to revenue accounts, balance sheets and prospects. This brings me to a point on which I disagree with Kent. He says: “Low-yielding gilts carry only interest-rate risks.” This is not so, because if they become high-yielding gilts when the fund needs to sell because of cash flow mismanagement, and liabilities are shorter than assets, there arises “a recorded and meaningful event”. Using market prices for valuation means investing as if the need to sell arises every year. In the early 1970s such a situation arose in a big way and there were several rescues mounted among small, new and what we contemptuously referred to as ‘one-product’ offices. At the time our regulatory body was the Department of Trade, and during one of their visits to our office one of my colleagues asked: “Why do you spend time here when there are several offices facing trouble?” The answer was, “We come to offices like this to find out what questions we should be asking.” Is this an idea we should be putting to the now-defunct department’s descendants, the FSA? As Kent says of actuaries: “They appear to exclude the need for a continuous focus on long-term investment strategies.” In the current regime they have no choice.

The editorial team welcomes readers’ letters but reserves the right to edit them for publication. Please e-mail letters@the-actuary.org.uk