Roman Halfin, investment risk officer at Enstar, speaking in his personal capacity, and not necessarily reflecting of his employer, explains why non-economic risks have overtaken economic ones in 2024 and how he contributes to the US insurer's investment decisions process
From an investment perspective, how would you describe the current risk landscape?
From my perspective, in the coming year, the risks are coming from non-economic factors and you can split them in two interconnected buckets, geopolitical risk and global elections.
In terms of geopolitical risk, we all know that there are a few local spots of conflict, especially Russia/Ukraine and Israel/Hamas/Iran.
These are major and important conflicts, but arguably they are localized geographically speaking. The risk from our perspective as a global company, is for these conflicts to widen either regionally or globally prompting more significant adverse impacts to the global economy. For example, it could impact oil prices, or in the case of Russia/Ukraine, if it spills out to other European countries, it would have devastating impacts and many significant effects from an economic perspective.
Regarding global elections, 2024 is an election year with around 60% of the global GDP going to the polls. Some elections are carrying more weight in terms of their potential impact of course, and here obviously the US presidential election is in the lead. Elections are important from an investment risk perspective because it induces high economic policy uncertainty. Look at the US election, depending on who is elected you have two radically different economic policies. I'm not saying that one is better than the other, or that one is good, and the other is bad, but they are different and as global investors we need to adjust for one or the other.
This needs to be put in the context we are in, which is central banks fighting inflation since 2022, and fears of recessions. These fears have now receded as economists believe the US economy is on a good trajectory to achieve a soft landing, but the non-economic uncertainty I just mentioned could jeopardize that positive outcome. Hypothetically, imagine the conflict escalates in the Middle East leading to a rise in oil prices, that would threaten the fight against inflation,perhaps making a soft landing unachievable.
And the last risk I would highlight is not a risk per-se, but it is something worth paying attention to, it's the valuation of stocks. They are at a record high, but I wouldn't call it a risk or something abnormal at this stage, but it is something worth monitoring and a factor to consider when making investment decisions.
Focusing on the non-economic risks for now, how do you integrate these into your risk framework, and how then does this contribute to the investment team's decision-making process?
Yes, that is the challenge, to make it quantifiable and something that is usable for decision making. And one of the main tools is stress testing. We look at hypothetical scenarios, using different research, white papers, analysis both external and internal, and try to translate it into market scenarios.
So, the first step is to go from a non-economic narrative to a macro-economic scenario. That is the previous example I gave you of oil prices going up leading to higher inflation and rising interest rates. That is a macro-economic scenario, but we then need to work out how this translates into market factors: what we would expect the impact to be on equity prices, real estate prices, credit spreads on corporate bonds and structured products. And we need to consider in that analysis our geographical and sector exposure.
It is a challenge because it's all hypothetical, but we will look at the correlations, the historical data, existing analysis and try to assess in a quantifiable way the potential impacts to actual market risk factors that will in turn impact our holdings. It's not a perfect science, it's an art and a science, but we can show direction and range and then the board, the executive team and the investment team can discuss the likelihood and potential severity of these scenarios, and that gives an informative foundation for decision making.
And if we look at the current environment – where non-economic risk is high, but economic risk is lower than it was a year ago - how does that currently impact Enstar's investment risk appetite?
We don't know the future, and we don't pretend to know the future, as the risk team. From a risk appetite perspective I just need to make sure we know how much risk we can sustain as a company and that if something goes wrong, we are going to be fine. So, we have a wide range of stress tests, and different metrics, and we supply that to the first line, the executive and investment teams, and they can make the decision if we are within our risk appetite, and how to change our portfolios given the current situation.
So, we set the risk appetite to ensure that whatever the investment decisions that are taken, under various hypothetical scenarios, we will remain within the company's risk appetite. We set up limits within which the investment team can make tactical decisions to seize current opportunities.
But I assume that there will be periods of time where the risk team will have to 'push back' more on some of the investment team's identified opportunities, right? So, are we in an environment currently where the investment team can easily find opportunities that fit the risk appetite? Or are we in an environment of 'heightened' conversation between the risk and investment team?
The short answer is that it is easier now. And I think you'll hear this from all the insurers, it's not unique to Enstar. The main reason for this is high interest rates. Insurance companies like high interest rates.
When interest rates were low, we had to go to riskier assets to find the yield we needed. Now when you have pretty decent returns on fixed income assets, why bother going into exotic real estate, hedge funds, private equity, if you can just invest in corporate bonds and get a decent return?
So, it's easier from this perspective, but then the question is 'what's your view of the interest rate curve?' and 'how long do you want to invest in terms of duration?'. In a simplistic way, for the risk person that I am, moving from risk assets to fixed income is great because it reduces the risk, but then if the investment team wants to invest in the long-end of the curve, that triggers questions around duration, asset liability management, and the risk team needs to make sure that we are still within our risk appetite. Because if you go too long or too leveraged on generally less risky fixed income assets you can end up taking much more risk than if you invested in more exotic investments like private assets.
You mentioned high stock valuations and the need to monitor that, would you say a bit more about this potential risk and what you are keeping your eyes on?
It's tricky because we are all biased because of the headlines. But if you look at the numbers, indeed, the valuations are high, if you look at measures such as price to earnings you see that they are at the higher end of the historical range. But it's important not to get emotional about it, valuations are high, but they are not too high, and when you need to make an investment decision, you should keep it in mind. If it's a long-term investment, then fine – you might be comfortable with the current prices, but if you know that it is a short-term investment you need to consider the current valuation. It's not something I have a strong view on, but as a risk manager you need to acknowledge and communicate on areas of heightened risk, which is what we are doing.
