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The Actuary The magazine of the Institute & Faculty of Actuaries

Actuaries’ need for investment strategy

Long-dated, low-yielding fixed-interestbonds have beendescribed as liability-driven investments.But liabilities often includebonuses or inflatable benefits. Thepreference for such bonds impliesactuaries cover only non-profit/fixed benefits or they have a deathwish. The situation is acute withthe credit crunch from defaultingUS sub-prime borrowers and theNorthern Rock crisis, while equitieshave risen since 2003 to theirhighest level for seven years.

Technically, the difficulties inusing FRS17 in valuations havebeen discussed in actuarial circles.Its distorting effects may be simplyillustrated: a rise in interest ratespermits the use of a higher valuationrate of interest, producing alower deficiency just at a timewhen the fund suffers investmentlosses from any previous switchfrom undervalued shares to overpricedgilts. The valuation can beonly a hypothetical exercise, whileany switch in investmentsbecomes a recorded and meaningfulevent.

Ill-advised exchanges from equitiesto bonds were encouraged byregulators, but advising actuariesmust share the blame on any consequentreduction in reversionarybonuses and the closing of finalsalary pension schemes. There hasbeen a void in the actuary’sarmoury claiming to make financialsense of the future.

Risk management may benecessary, but it can be appliedonly with due consideration ofeconomic/market consequences.Equities offer the prospect ofreward while low-yielding giltscarry only interest-rate risks. Bondsprovide a rare alternative whenequities are overvalued – as in thelate 1990s in the dot-com boom.

Actuaries should then haveinstructed their professionalinvestment managers to avoid orreduce shareholdings. Contrarianviews are difficult for the professionals,risking losing funds undermanagement and their jobs on apremature cutback in equities. Butinvestment actuaries should beable to take a longer, more reasoned/common-sense view. Therise in bond prices is probably finishednow, while higher interestrates make progress in investmentbanking, private equity deals, andhedge funds more difficult; butequities may not yet have reachedtheir peak – despite their formidablerun.

Have actuaries lost the plot ininvestment management? Anatural affinity in mathematics,but with professional emphasis ontheory, compliance, regulations, modelling, and risk management,they appear to exclude the needfor a continuous focus on longterminvestment strategies.

Kent Sandom’s letter is the editor’schoice for ‘Letter of the month’. Hewill receive a fountain pen, courtesyof HBOS.