“Diversification is the only free lunch”

Insurance Investor speaks to Daniel Blamont, Head of Investment Strategy at Phoenix Group about the best strategies when it comes to diversifying investment portfolios

Insurance Insight Editorposted on Thursday, August 08, 2019

This excerpt is taken from a roundtable: ‘What strategies are proving successful in driving returns from an asset allocation strategy and achieving diversification at the lowest capital cost?.’

You can read the full roundtable in the research report Insurance Asset Management – Europe 2019, which can be downloaded here.

Insurance Investor: How much more time, or not, are you spending on asset allocation decisions these days?

Daniel Blamont: My role is titled head of investment strategy, though I have always, even in previous positions, spent time on investment strategy and diversification.

We know that the market’s quote is that, ‘diversification is the only free lunch’ and so obviously it is continually worth looking at.

From my point of view, and from more of an annuity angle, diversification is key. If you just go into a portfolio of corporate bonds and gilts, you don’t have diversification, so it is quite hard to achieve it within just one broad asset class.

"To achieve diversification, you need to make substantial efforts in some cases."

Another interesting quote from Markowitz Is that in theory, there is no difference between theory and practice but in practice there is and that is where this free lunch may actually not be so free.

To achieve diversification, you need to make substantial efforts in some cases.

When you are an annuity provider or pension fund, trying to match your liabilities with fixed income, diversification within corporate credit is the challenge.

There has been a lot of talk about private asset classes and we know that this is one source of diversification, extra liquidity premium, and returns, but the extra effort required to potentially carry internal ratings, come up with a valuation methodology, and find the right asset manager, make them a difficult area to allocate to.

It isn’t just the private sector which is difficult, as even within the public sector, if you are say a UK investor who is going to move into other countries, your asset manager needs to be able to deliver that global credit portfolio.

If you want to go into particular segments such as emerging markets and other types of quasi sovereign debt across Europe, then it requires extra effort.

There is hedging that comes into play with the liquidity margin being challenging, so it isn’t necessarily risk versus return but more effort versus return.

II: Given the wide array of assets, strategies, types and geographies that are possible for insurers to invest in, how much more difficult is that making it for you to choose and structure your allocation?

Daniel: The more choice the better so we do welcome it. There has been a foray into private assets and a lot of insurers have realised the merits of having a global portfolio.

We have a Strategic Asset Allocation plan (SAA) and try to provide some sense of direction.

If you end up being too prescriptive and think about things as asset classes, then it can be difficult when deciding what asset class it fits with.

"We have a Strategic Asset Allocation plan (SAA) and try to provide some sense of direction"

If you are looking at local authority loans on the one hand and US credit on the other, is it then OK to do US municipal debt?

Sometimes you have this difficulty about being too prescriptive, where you end up closing doors but also you can be too broad and risk going into areas without having clear plans, so you need to strike the right balance.

This is where we have learnt to have a SAA and try to achieve diversification within it, to be clear as to what kinds of risks are OK rather than what kinds of asset classes.

II: When it comes to multi asset strategies, do you use these internally or externally?

Daniel: Within asset types we feel that it is good to have the same asset manager. We do corporate bonds, infrastructure Loans, CRA loans and equity release mortgages.

These four categories are invested in separately of one another, but in the corporate credit area it is all under our strategic partner, Aberdeen Standard Investments.

"Within asset types we feel that it is good to have the same asset manager"

We see merit in having them manage the whole lot, which could include private placement and different sectors and geographies.

They can manage this because there are similar types of risks that are all under one mandate and so they are able to provide that diversification, as they know they can build a diverse portfolio without different strategies going against each other.

This excerpt is taken from a roundtable: ‘What strategies are proving successful in driving returns from an asset allocation strategy and achieving diversification at the lowest capital cost?.’

You can read the full roundtable in the research report Insurance Asset Management – Europe 2019, which can be downloaded here.