Weiss Multi-Strategy Advisers, a $1.7 billion New York-based hedge fund, wants insurers to consider a new type of portfolio customization. The firm calls it “enterprise-driven investing” (EDI), and recently authored a white paper making the case for why insurers need to change how they construct their portfolios in order to better address common allocation pitfalls.
According to Bill Poutsiaka, independent insurance consultant, author of the paper and developer of the EDI model, insurers have opted to stick with classical allocation models despite dwindling performance. “Managers need to catch up to customization when it comes to creating investment portfolios for insurance,” Poutsiaka contends. “The traditional mix isn’t always going to get you to your goal.”
Insurance balance sheets tend to be heavily regulated pools of long-term capital. As a result, allocators opt for fixed income and other vanilla investments in the hopes of maintaining stability over many decades. Poutsiaka says that with the advent of new financial instruments and technology, insurers should consider new asset classes and a more outcome-oriented allocation model.
EDI works by adopting many of the same principles institutional investors use for outcomes-based portfolios and adapting them for insurance. Poutsiaka notes that insurers tend to run into significant portfolio design challenges because of the long time horizon associated with insurance portfolios. Allocations are made with a one-size-fits-all approach, leaving the portfolio vulnerable to changes in market, regulatory, and business conditions. With EDI, allocators prioritize a specific set of financial goals and design the portfolio and its performance metrics accordingly. “Customization begins with insurance business segments and ends with circumstances specific to each company,” Poutsiaka says. “Creating this picture is critical to the formation of an investment strategy.”
Investment horizons should also be capped; rather than investing for a nebulous “long term”, portfolios should be designed based on clear cut durations such as three or five years. By aligning outcomes, performance metrics, and duration, more consistency is embedded into the investment process and allocators set up fixed points in time for reevaluation. These conditions make it more feasible to invest across asset classes, capturing medium-term yields alongside long-term return.
Poutsiaka says there is a unique opportunity for EDI right now given the level of change and innovation underway in the business of risk transfer. “In the world of risk transfer, there is a lot going on, we are even starting to see growth in start-ups,” he explains. “These changes create opportunities to improve results when they are managed through a comprehensive and systematic management process like EDI.”
The full paper is available here.