David Braun talks to Stephen Hyams about managing portfolios of fixed income investments for insurance firms, banks and retail investors
David Braun, managing director and fixed income investment manager at PIMCO, is an actuary with a strong background in insurance and risk, experience which he says is invaluable when running investment portfolios for insurance companies.
Speaking via video conference from his New York office, Braun describes the goals and challenges that this entails:
"In insurance, investors differ in their objectives, liabilities and preferences, so it requires a customised approach to investment management. Our job is to run the portfolio as optimally as possible, subject to the investor's constraints."
These constraints include regulatory ones and those self-imposed by the insurer's risk preferences. A major factor is the relative importance an insurer places on book (or redemption) yield, as used for accounting purposes, versus total return. Braun explains: "Most have a dual focus but you can't optimise both, so there's a series of trade-offs that need to be made. You have to decide where you want to be on that spectrum."
A book-yield objective will result in a total return that is reduced and achieved over a more extended period, but Braun says: "We don't hide behind the insurance constraints of being a book-yield investor and saying you have to be passive; there are always trading opportunities that can enhance performance."
I ask how performance is measured. Braun explains that reporting to most investors is on a quarterly basis. "We don't just pick one number, like investment income or total return; that's an antiquated way of looking at it. Equally you need a mosaic of risk metrics to really measure the risk you are taking. We look at the portfolio under many different lenses: accounting income, similar to book yield; total return over one-, three- and five-year periods; realisation of capital gains and losses; perhaps the migration of unrealised gains and losses; risk-based capital consumption; lastly, and critical for insurance companies, monitoring default progression and the upgrade versus downgrade ratio.
"We believe in active portfolio management, despite guideline constraints, so we decided to score it by creating a book-yield 'alpha attribution' tool, which we use with the majority of our insurance clients who are focused on book-yield objectives." This involves decomposing the change in portfolio book yield. Then, to measure the impact of active management, they compare actual performance with what a passive manager would have achieved with the same starting assets and cashflows over the measurement period.
I ask about environmental, social and governance (ESG) investing. Braun replies: "This is all about long-term impact; insurance companies are probably the longest-term investors in the market, so, perhaps unsurprisingly, they are at the forefront of ESG investing."
Braun explains that inflation is not a big issue for US insurers, since a lot of life and annuity liabilities are not linked to inflation.
"The exception is worker's compensation, where there is a long-dated inflation element; rather than try to hedge the risk, insurers monitor it, design the products appropriately and invest in a healthy dose of real assets that should keep pace with inflation."
Beyond insurance asset management experience
We briefly touch on banks. Braun says: "Lending hasn't kept pace with deposits, so banks have more to invest and are looking to the public fixed-income markets to put that money to work rather than sitting in short-term treasury bills, so as to earn a yield commensurate with what they can get on lending that money out -
a diversified, fixed-income portfolio, very high quality and relatively low duration of three years or so."
Braun also explains how his portfolio management career has expanded beyond insurance, towards broader investment fields: "Two to three years ago, I joined the total return portfolio management team, not just for several of our institutional clients but also for two of our flagship retail funds. I believe that running a broader portfolio helps us to better serve insurance clients; we're looking at the full market opportunity set to find the best economic trades and then making sure they are expressed in a capital-, accounting- and tax-friendly way."
A low interest rate environment
On the challenges of low interest rates, Braun comments: "Following the global financial crisis in 2008, we took the view that interest rates were destined to stay low for the next decade, owing to the massive amount of deleveraging required and the prospect of relatively low economic growth; this enabled us to stay fully invested over the period. We still believe that interest rates will remain low compared with the past.
"Low rates are certainly a challenge. In health, property and casualty, and reinsurance, underwriting or expense management are the key factors; the investment piece helps but is often not critical to making the product sale, so they are less exposed to interest rates being low. On the life and annuity side, the impact has been substantial, as the assets were less sensitive than the liabilities to a fall in interest rates, resulting in a relatively large increase in value of liabilities, which therefore gave rise to a funding gap. The good news is that these companies have redesigned their products, so they are less susceptible to a sustained, low-rate environment."
Braun explains how insurers have sought to adjust their asset holdings to combat low interest rates. "We've seen a modest reduction in credit quality; a fall in allocation to bonds rated A or higher and a corresponding increase in BBB-rated bonds. There has also been a lot more interest in capturing illiquidity premium, such as by investment in private assets: corporate debt, direct lending; commercial mortgage lending and infrastructure. Lastly, there's been a slight increase in the use of alternatives."
On the retail side, Braun comments: "We are seeing a lot more retail investors focusing on income. Yes, they want full total return, but there's a growing cohort who really want income and they want stability of income. Perhaps that's a function of being in a low-rate environment for so long." He explains: "My background in insurance can be deployed here - you're taking a longer-term view, trading the portfolio more slowly to maintain the yield, but still very much trying to be an active manager."
Braun also discussed the economic and market outlook: "We expect the recent global synchronised growth to continue in 2018 and beyond, in the range 3-3.5% globally and 2.25-2.75% in the US, but we think this is as good as it will get, given some of the risks out there." He explains that these risks stem from the current US fiscal stimulus, which stores up useful ammunition for when it might be better needed later and which could be inflationary.
Braun believes a lot of fixed-income markets are fully valued.
"I'm talking about generic investment grade credit fixed income valuations being at historic highs when you adjust for risk. We're trying to avoid taking a lot of broad market risk. Instead, we think that bottom up research is required to find the credit and securities that still offer a decent risk-reward proposition."
Actuaries in investment management
We finish by discussing Braun's career and his advice for actuaries thinking of becoming institutional investment managers. After qualifying as a Fellow of the Society of Actuaries on the life side, he decided on an investment management career. To pave the way, he took a consulting job carrying out asset liability and risk management for banks and insurance companies. He continues: "After two to three years, one of my clients approached me about working in their investment department, still doing asset liability management but also building a derivatives trading function. I eventually became the chief risk officer in their investment division." He joined PIMCO in 2009 to help grow its third-party insurance management business and moved to the New York office to launch its new trade floor in 2011.
Braun notes that actuaries have the right skillset for investment management but stresses: "There is no right answer; it's much more a blend of art and science, so you've got to get comfortable with that. I do believe in getting your Certified Financial Analyst qualification. Also, if you want to be a fixed income investor, a huge part of it is risk management, so getting my certification in financial risk management was crucial." He notes that risk management has grown in importance since the global financial crisis and is another very promising career for actuaries.
Braun continues: "You've got to augment the professional qualification with self-learning, which for me is reading a lot of economics, fixed-income and risk management textbooks. Also read about behavioural finance, and financial markets history books such as about the Great Depression or Tulip Bubble. This was very valuable to me in building that knowledge to understand what worked and didn't work during those periods.
"My further advice is to take stretch assignments and learn new things, especially in your first 10 years. Don't worry about title and managerial progression. That will improve the odds that you find something you're passionate about and good at, leading to a long, successful career that doesn't even feel like work anymore."