12 June 2024

Fireside chat with Phoenix's Eakins: The days of insurance investments run by actuaries are gone

Phoenix chief investment officer Mike Eakins took part in a fireside chat at Insurance Asset Risk EMEA 2024 conference, here is an edited transcription of the session.

What do you view as the main geopolitical events affecting markets in 2024 and beyond?

The reality is, every day geopolitics is changing, so if you asked me that question on Friday, the answer I would have given would be dramatically different from the answer that we're about to discuss today. Why? Because geopolitics is a continuous evolution.

It used to be the case back in the day, if you wanted to be a senior investment or finance professional, you had to have a background in either fixed income or equity. That's no longer the case, you need to have a view on geopolitics because geopolitics is literally shaping markets day in and day out, and having an impact on the investment return to the most important stakeholders in this room, which is the consumer.

But to your question, we look at this principally through two lenses. One is right now, there are four theatres of war taking place globally, some of them really close to the UK. Now, of course, humanitarian aspects, what unfolds in those theatres of war is of paramount importance, but it does impact markets. And we saw that in terms of the inflation shock that we experienced in 2022. Arguably, we would have had an inflationary shock given the stimulus through COVID, but it was exacerbated by Russia invading Ukraine.

The second, of course, is 2024 is a bumper year for elections, over half the world's population is going to the polls this year. President Macron last night decided to throw another one in the mix. But again, all of this has impacts on our day-to-day job. You only have to look at the price reaction to OTS this morning, 50 basis points worse than their comparables.

From an investment perspective, we don't have a silver bullet or a crystal ball that we can look into, far from it. But just being aware of these risks, and how they manifest themselves is really, really, important. Everyone says every year is unprecedented, this year literally is unprecedented when four billion people are going to the polls, and the probability that there will be some outcome that the market has not priced in is almost 100%.

You say "you have to be aware" but how are you hedging against these risks? For elections it is binary so perhaps easier? But for wars?

At Phoenix we run a really simple business. We do two things. One, we help people save for retirement and the second thing we do is we pay them an income in retirement. It's a really simple business and we manage those risks in a really simple way as well. We've decided which risks we designate as rewarded, and which risks we designate as unrewarded. And for Phoenix, we've designated risks like inflation, interest rates, FX as unrewarded, so we hedge those risks. For market risks like credit and property, we view those as rewarded risks. So, we really look at it again, through a really simplified lens, which risks do we want and which risks do we not want?

Now, as it relates to geopolitics, of course, markets think they're perfect, and they think they've got the perfect answer and can price everything in, but as we know, they don't.

Any risk profile has a left hand tail outcome, is typically adverse, and a right hand tail outcome, typically pretty positive. And so even when these risks manifest themselves, it's possible to frankly, end up in the right hand side of the tail distribution, in a positive sense, the classic example would be in the Liz Truss era. In the aftermath of the mini-budget, long end indexes and gilts went down trading 48p / 49p, and then rallied back to 125, when the Bank of England intervened. So, if you'd had the wherewithal to actually allocate money to indexinggilts , in those heavy days of the Liz Truss era, then that would be fantastic. But actually, most people were busy making sure that they had enough cash and gilts in their collateral accounts to be able to post as collateral.

We talked this morning of the stand-off between central banks and bond markets – how do you see this playing out?

Mike EakinsIt's going to be a really difficult one to see how this plays out. I don't actually think it's such a standoff. There's various standoffs taking place, right. And we all know that when bond markets standoff against anyone, they typically win.

The principal risk that we see is divergence and divergence of monetary policy between the US and the UK, and Europe. The US economy is literally on fire. People in the US feel sufficiently confident that they're going out spending money, to the point that the Federal Reserve has had to push back its expectation of when it can ease monetary policy, principally through lowering rates. In the UK, and in Europe, unfortunately, the economy is not in the same robust position, to say the least, quite frankly. In the Eurozone, and in the UK, central banks do need to ease monetary conditions as the ECB did, and as the Bank of England will undoubtedly do, probably later in the summer.

That causes a risk on two levels. One is, if the Bank of England and ECB don't ease monetary policies fast enough, then their respective economies will get into trouble very, very quickly. There's no doubt about it. If you look at debt to GDP levels in the UK, and indeed in the euro zone, and then you try and equate that with economic growth, economic growth is so anemic, but you can't get the debt to GDP levels and low economic growth to standup. Whereas you certainly can put together an argument in the US. The US also has high levels of indebtedness. Central bankers in the UK and in Europe were slow to the game in terms of getting to grips with inflation, and seeing how severe inflation would be. And it would be a real shame, if they were even slower to the game to realize that they have to ease monetary policy in order to simulate economics.

And the second risk is that the BoE and the ECB, do the right thing to try and stimulate economic growth, but the US economy continues to bounce, and that the Federal Reserve doesn't cut this year. And then you get a real divergence, which principally will manifest itself through currencies and FX markets and of course in terms of inflation. No one should underestimate the strength of the US economy. They have now recorded unemployment below 4% for 30 consecutive months. That hasn't happened for 50 years. The US economy is super, super strong. Supercharged. The question is can the consumer keep pace?

You mentioned the level of indebtedness in the US. Are you concerned about that?

Anyone who says they're not concerned about debt to GDP levels being at their highest level since the Second World War, probably needs to redo their A Level in economics. And in Washington, they are concerned about it and absolutely rightly so. It's only going to take one wobble in one of those auctions for it to really skew the market.

How does this macro and geopolitical backdrop impact large asset owners' approach to portfolio management?

As we look at our portfolio management, as I said we are a really simple business, we do two things, we want to help people save for retirement and two, we pay them an income in retirement. Fortunately, for both of those activities, the investment time horizon that we invest, either in our customers assets or shareholders assets, is measured in single digit multiple decades, not years. Now, you could be really blase and say, well, that means you don't really look through all this noise, because, as we discussed previously, there's opportunities and there's risks. But fundamentally, when you take that long term view, you can look through some of this, but what you need to be is really opportune and agile in terms of making those portfolio management decisions.

What we've done is build out capabilities on three fronts.

The first is people. Over the last four years, we've significantly invested in our people, we've hired people from asset managers, from competitors, from investment banks. We've always really focused on people who've got direct financial markets expertise. Because again, if you look back at the insurance company of old, who really ran investments, ALM and portfolio management typically? It was actuaries who put their hand up and said 'I might have a go at this investment or ALM'. I'm not here to downplay the role of actuaries at all - as a current fully paid up member of the profession myself - but actuaries are great at many things, principally discounted cash flows and assigning probabilities to them, but managing complex balance sheets, where you're taking investment decisions and managing risks over multiple decades, that really should be left to financial markets expertise.

The second area we invested in is technology. You will have heard our Group CEO, at our full year results, announcing a £100m investment in IT and infrastructure to support what we're doing in asset management. Now all of our asset data, all £270bn we have on the cloud - we are Amazon Web Services largest European insurance clients. So, technology has been a major source of investment, and we believe a key enabler to managing these risks. And with tech, you've never done, you've got to keep investing in the hardware, the software, and the people. Which is why earlier this year, we created a dedicated quantitative engineering hub. Because again, if you think about the balance sheets that we run, even simple balance sheets, the risk is that they get embedded within them. You can't explain using A-Level or degree level mathematics, you need proper quant engineers to understand those risks, model those risks, and then to enable really active decision making.

And the third and final area of capabilities that we've built up is our risk control. So, making sure that when we invest in private assets, or we take certain hedging risks, that we do so in a highly risk controlled manner.

Building up those three capabilities, people, technology and risk and control doesn't give us the silver bullet, the crystal ball, but it certainly enables us to be much more risk aware and then to take and seize opportunities. Because when you have the right people, the right technology and the right risk and control environments, you can then afford to be super agile, which, let's face it, that's not something UK life insurers are typically known for.

How do you see the impact of AI on asset management? And how are you using it?

So, it's just amazing how every company strategy and presentation now has to have AI in it. There's no doubt about it, it will be a key enabler. But the reality is that AI is embedded in our strategy, it is part of our forward-looking thinking, just for simple stuff like document screeening. And, one of the things that causes so much grit in the system is collateral arrangements, the fact that we have different CSAs with different banks, just having some technology solution that enables you to screen those documents and to weed out some potential areas of normalization is key.

Some think AI is a gimmick driven by Fear of Missing Out – FOMO – I think that is misguided. Look at markets, the top three stocks in the S&P 500, today, are tech companies and they represent over 20% of the entire market capitalization of the S&P 500, which hasn't happened for 20 years. So, AI is definitely here to say.

Why was Phoenix so compelled to be a founding signatory to the Mansion House Compact? And how will the insurance industry deliver on its objectives? And how will it play out under a potential Labour government?

So we were one of seven founding signatories, and we said we would invest up to 5% of our defined contribution assets, which for Phoenix is around £200bn in so-called productive assets.

These are life sciences, infrastructure and equity, venture capital, and early-stage growth.

We signed up for that because we believe the UK saver has been chronically underserved, by frankly, a race to the bottom, as cheap as chips approaches to the investment of assets underpinning defined contribution schemes. And as a result, you'll see that the asset strategies are very weighted towards index tracking strategies. And fundamentally, we don't think that's the right thing. We believe we should focus on a net investment return. And if you compare the UK pension market on the global playing fields, it's even more stark. Because today in the UK, we invest about 9% of our pension assets in so-called productive assets. Now, the average of the top seven developed market nations in terms of their pension assets, their allocation to the same productive assets is 23%. We're 14pp shy of our international peers. And by the way, that's significantly weighted because the UK is the second wealthiest nation globally in terms of pension assets. So 14pp behind our peers in terms of allocations to productive assets, that has a massive cost to the end consumer. It also has a massive cost to the UK economy.

So we signed the Mansion House Compact with the end consumer in mind, we manage the , pension assets for 12 million customers in the UK. Furthermore, we believe that investment returns are the single biggest lever that we've got to improve the lifestyle and the lives that people can have in retirement.

At an event last week, Mark Carney called on new mandates for the Bank of England and FCA to support UK's net-zero push – thoughts? – And do you think now it is down to policy makers and regulators to take sustainability objectives over the line?

The role of sustainability is here to say, we've embedded it, as others have done into our investment decision making. Mark Carney does an amazing job of being a very senior former policymaker who keeps putting sustainability back on the agenda. So, we welcome anything that keeps sustainability on the agenda in a manner which ultimately protects the interests and outcomes of our consumers. We welcome what MrCarney said last week.