5 April 2023

Old dog, new(ish) tricks? Lloyd's CIOs get all esoteric

Lloyd's syndicates have held onto non-mainstream investments even as yields have risen – with some mixed results, David Walker finds

In a year when yields on core fixed income roared back to life, chief investment officers at Lloyd's showed a resolve to retain some decidedly non-core holdings.

Yes, the market's strong tilt, of 69%, was 'fixed income' - and that was indisputably a boon for the likes of Brit's Ki syndicate, whose yield more than quintupled from 0.8% to about 4.5%, during 2022.

But beyond the mundane, other CIOs were revealing some very un-boring stuff.

MAP Underwriting's syndicate 2791 kept 4% of its pot in bullion ETFs, for instance, which looked like benefitting big time when gold rocketed from about $1,800 per ounce to top $2,050, before dropping back to a modest 0.7% losing position. Still, US debt lost it more (3.5%) over the year, and 2021/2022 were the first two years of consecutive investment losses in MAP's 22 years.

MAP also kept onto a specialist US manager playing the long end of the Treasury yield curve – a part driven by inflationary expectations. In H2 MAP "propped up" its investments "given that the macro-economic evidence is still showing that long term future growth will be constrained by the over indebtedness of global economies, and this will in turn put downwards pressure on inflationary expectations".

Beazley Furlonge's syndicate 623 lost "modestly" more on its own equities than the 18% plunge in global share values, but it had just 1.8% of its portfolio committed to them "and all of our other capital growth investments achieved positive returns". Among those others were hedge funds, which "in particular, proved resilient in the difficult market conditions, returning more than 7% in a year when the hedge fund universe recorded losses".

QBE's syndicate 386 had off-piste growth assets including "listed funds, unlisted property, infrastructure assets and EM equity".

Where syndicates held more banal investments, and lost money on them in 2022, the losses were more often than not 'paper', not crystallised, so the market-wide £3.1bn net investment loss - not quite offset by its 2022 underwriting profits worth £2.6bn – is entirely likely to right itself for held-to-maturity bonds.

Still, executives across syndicates described 2022 as unusually tough – for MAP's active underwriter Richard Trubshaw, it was "a year to remember" for US bond holders, for instance.

US shares shed nearly one-fifth of their value, the S&P 500 turned in its worst performance since the also-forgettable 2008, global bonds careened into this century's first bear market for them, US Treasury yields at shorter maturities leaped by over four percentage points – their biggest increase in over 50 years – and inflation ran riot.

And the good news? The future looks bright

The future, at least, may prove brighter by virtue of reinvesting cash into higher rates.

Cincinnati Global's syndicate 318 noted such improvement "means returns are expected to be strong, as any further hikes from central banks are likely to be limited and are currently compensated for by the yields available". But the syndicate also echoed many peers, in predicting less central bank support for markets means "volatility will be elevated as markets trade between the inflation and recession themes."

Richard Watson, Inigo's chief executive officer at syndicate 1301 was typical of many colleagues in reporting an investment return loss of $5.1m (2021: $400,000 loss), which was made up more of paper losses, worth $6.9m (2021: $0.6m) than of realised losses, worth $3m (2021: $900,000), with investment income sitting between those two figures, at $5m - which was well up from $1.1m in 2021, since reinvestment yields have risen.

Also not atypical was Inigo's paper losses coming "mainly from the fixed income portfolio, primarily comprised of corporate and government bonds". And also not atypical was Watson using BlackRock Investment Management (UK), and Payden & Rygel Global - though nor would New England Asset Management nor Conning have been out of the ordinary, for that matter.

The effects on fixed income portfolios of rates rising in were stark.

Atrium's syndicate 609, aided by NEAM and Conning, ended 2022 nursing a £32.9m loss (2021: £1.2m loss), or 4.2%, reflecting "the challenging market conditions as rates increased and credit spreads modestly widened". But Atrium reasoned its policy is still hold-to-maturity and "as a result it is expected that these unrealised losses will unwind in future periods".

A bank loan fund that syndicate 609 had 8% of its assets invested in also lost ground – by 1.2% - "due to the floating rate nature of the portfolio and limited allocation to high yield bonds", though it had generated 5% profits for the syndicate in 2021.

At syndicate 1084, the active underwriter Kelan Hunt reasoned that high-quality fixed income holdings, and good duration-matching meant Chaucer's team could "take a longer-term view on total return", rather than being derailed by a 4.9%, loss worth $94.9m in 2022, nor by its $9.5m loss in 2021, for that matter.

Income, not returns, the focus

Mark-to-market losses at Chaucer's syndicate amounted to $124.2m in 2022, after chalking up $32.8m of them in 2021, but Hunt wrote: "The syndicate's focus is on income, with total return being secondary."

Good, then, that interest earned on the portfolio grew by $8.7m to $38.4m – and music, no doubt, to the ears of GSAM and the owner's affiliated manager, China Re Asset Management (Hong Kong).

Newline regarded the £7.7m investment return in 2022 (2021: £29.7m) for syndicate 1218, driven by coupons and dividends, as "satisfactory against the backdrop of both the US equity and bond markets falling together in 2022 – for the first time since the late 1960s".

Beazley Furlonge's syndicate 623 looked to better times, after reporting a "significant" $22.3m, or 2.4% investment loss for 2022, despite reducing portfolio duration for much of 2022, "which helped to reduce the adverse impact of rising yields".

It warned that "rampant inflation and rising interest rates...remain unresolved, such that investment returns are likely to remain volatile," but reasoned at the same time that a portfolio yielding 4.7% by year's end "suggests that future investment returns may be better than we have seen for some years".

The syndicate also reasoned that at least the rising rates that triggered investment losses in its $990.4m (2021: $843.9m) portfolio had also reduced the present value of the syndicate's Solvency II liabilities, leaving its capital position "not materially affected".

QBE's syndicate 386 was unable in 2022 to follow in its footsteps of some previous years, when stagnant fixed income yields could be defrayed by good 'growth asset' performance.

Instead, the 5.4% negative return, worth £53.3m, that came "predominantly due to increases in market yields on fixed income" was mildly sharpened by the 8% allocation to 'growth assets' losing 1.5%.

Environmental climate

QBE also turned its attention to climate change, as a UN-convened Net-Zero Asset Owner Alliance member since 2020, and called global warming "a material financial risk in and of itself [which] can also act as a risk multiplier. The past may no longer be a good guide to the future; risk models based on historic experience need to be adjusted to allow for the impact of climate change over time".

In ringing this warning bell, QBE was, of course, far from alone.

At syndicate 727, SA Meacock's, underwriter Alec Taylor wrote : "It is widely accepted that the climate is changing inexorably and at uncertain speed. Today we understand that beneath our feet the earth's core is spinning at a rate different to the rate at which the surface rotates. Above our heads, the track of the jet stream mimics the tail of an angry cat. We never take a view of the physical world that extends out more than 12 months in time but doing even this today feels as risky and uncertain as it has for a long time. It takes some credulity, temerity even, to commit capital to exposure to the natural world today based largely on a historical perspective and without examining the balance of benefits on a case-by-case basis."

One syndicate was benefitting from its forward-thinking approach to sustainability.

Brit's Ki syndicate 1618 has a 'Funds at Lloyd's' letter of credit (LOC) agreement to finance growth, with pricing depending on "the compliance of the syndicate's investment portfolios with ESG targets".

Mark Allan, director at Brit Syndicates and chief executive officer of Ki Financial, explained "this builds on the investment guidelines that the syndicate has established for its third-party managers, which incorporate ESG principles and targets, and will help the syndicate build a sustainable footprint."

The structure seems to be working out for Ki – last October it increased the LOC agreement by $50m to $180m, taking on some new bank partners, and Allan noted Ki's backing of the planting of 117,000 new trees, and supporting four women – of which it since hired three, permanently - to take 'nano-degrees' in computer coding and data.