presentation to pci investment seminar
TRANSCRIPT
Getting a Grip on Key Investment Issues
Alton R Cogert, CFA, CPA, CAIAPresident and Chief Executive OfficerPresident and Chief Executive Officer
September 16, 2009
Getting a Grip on Key Investment Issues
Today’s Investment Environment
Your Company’s Investment Process
What to Watch For in the Near Future
Your Company’s Key Investment Issues
2
Not Very Long Ago…
Prior to 2008Interest rates fell – lower yields for risk free securitiesS d d l ti f dit i k &Spreads narrowed – less compensation for credit risk & prepayment risksHousing prices had been rising
InvestorsInvestorsReached for yield, took more risk, with less compensationFound “attractive” yield in sub-prime mortgages
Investment BanksCreated new structure to create more yield with leverage and less transparencyPackaged sub-prime mortgages & utilized those securities within their structured vehicles to provide more yieldtheir structured vehicles to provide more yield
Rating agenciesAccommodated by giving higher ratings in structures where the risks were not fully understoodrisks were not fully understood
3
How did this turn into a crisis?
In 2008, when interest rates started to riseSub-prime mortgages increased defaultSt t d d t l dStructured products unraveledLeveraged financial institutions brought close to collapseLehman bankruptcy seized credit markets – trading haltedCredit problems extended into a global markets crisisCredit problems extended into a global markets crisisDeveloped into deepest recession since the Great Depression
“Spread-products” (corporate bonds mortgage-backed bondsSpread products (corporate bonds, mortgage backed bonds, and structured products) underperformed risk-free (Treasury) bonds as spreads widened through March of 2009
2nd quarter 2009 spreads narrowed & corporate bonds recoveredYet, defaults and bankruptcies increased
Defaults increased in sub-prime mortgagesSome structured products (backed by sub-prime & defaulted bonds) have not recoveredbonds) have not recovered
4
And Today…
Spreads still historically above averages, but what average should be used?US Government spending like drunken sailors…but is it
h?enough?Unusually steep ‘risk free’ US Treasury yield curve…but how risk free is it?C b t i fl ti d d fl tiConcerns about inflation….and deflation.Equities – too high or the deal of the decade?
R ti i th l t i t j tif th i iRating agencies…on the prowl, trying to justify their improper business model. Few have 100% trust in rating agencies, but no investment policy excludes ratings from their list of limits.Regulators accommodative (fair value ‘permitted practices’)Regulators…accommodative (fair value, permitted practices ) but still concerned about some insurers.Accountants…the politicization FASB potentially means anything can be ‘up for grabs’.y g p g
5
History of 5-year Treasury Note Yields – Yield changes over time
6
History of Yield Curves – Yields on 2 and 10-year US Treasuries –changing shape of the curve
7
Indices of yield spreads for BBB (blue) A (yellow), and AA (red) rated bonds
8
Your Company’s Investment Process
Consistent Investment Results REQUIRE aConsistent Investment Results REQUIRE aConsistent Investment Process
9
What to Watch For in the Near Future
Greater Emphasis on Risk Management, because Uncertainty Will Grow not Subside Over Time
Look for hidden risk. It’s there, but not being discussed to any great degree.Consider the ‘next shoes to drop’
Linked Effects of Investments – ‘Hidden’ Correlations
Continued Politicization of Accounting
Continued/Increased Board Interest in the Investment Process
E t t H M f ‘W ’ N S Thi B f i OExpect to Hear More of ‘We’ve Never Seen This Before in Our Lifetimes’….Is Your Company Prepared?
10
What Are Your Company’s Key Investment Issues?
Risk v Reward Reconsiderations?
Yield v Total Return?
OTTI Evolving?
Accounting Tail Wagging the Investment Dog?
Rating Agency Scrutiny?
ERM/DFA – Lip service versus Reality?
Board/Senior Management Politics?Board/Senior Management Politics?
Other?
11