Presentation to PCI Investment Seminar


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The annual PCI Investment Seminar was held in Phoenix, AZ.

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Presentation to PCI Investment Seminar

  1. 1. Getting a Grip on Key Investment Issues Alton R Cogert, CFA, CPA, CAIA President and Chief Executive Officer September 16, 2009
  2. 2. Getting a Grip on Key Investment Issues Today’s Investment Environment Your Company’s Investment Process What to Watch For in the Near Future Your Company’s Key Investment Issues 2
  3. 3. Not Very Long Ago… Prior to 2008 Interest rates fell – lower yields for risk free securities Spreads narrowed – l S d d less compensation f credit risk & ti for dit i k prepayment risks Housing prices had been rising Investors Reached for yield, took more risk, with less compensation Found “attractive” yield in sub-prime mortgages Investment Banks Created new structure to create more yield with leverage and less transparency Packaged sub-prime mortgages & utilized those securities within their structured vehicles to provide more yield Rating agencies Accommodated by giving higher ratings in structures where the risks were not fully understood 3
  4. 4. How did this turn into a crisis? In 2008, when interest rates started to rise Sub-prime mortgages increased default Structured St t d products unraveled d t l d Leveraged financial institutions brought close to collapse Lehman bankruptcy seized credit markets – trading halted Credit problems extended into a global markets crisis Developed into deepest recession since the Great Depression “Spread-products” (corporate bonds mortgage-backed bonds Spread products bonds, mortgage backed bonds, and structured products) underperformed risk-free (Treasury) bonds as spreads widened through March of 2009 2nd quarter 2009 spreads narrowed & corporate bonds recovered Yet, defaults and bankruptcies increased Defaults increased in sub-prime mortgages Some structured products (backed by sub-prime & defaulted bonds) have not recovered 4
  5. 5. And Today… Spreads still historically above averages, but what average should be used? US Government spending like drunken sailors…but is it enough? h? Unusually steep ‘risk free’ US Treasury yield curve…but how risk free is it? Concerns about i fl ti C b t inflation….and d fl ti d deflation. Equities – too high or the deal of the decade? Rating R ti agencies…on th prowl, t i t j tif their i i the l trying to justify th i improper business model. Few have 100% trust in rating agencies, but no investment policy excludes ratings from their list of limits. Regulators…accommodative Regulators accommodative (fair value ‘permitted practices ) value, permitted practices’) but still concerned about some insurers. Accountants…the politicization FASB potentially means anything can be ‘up for g y g p grabs’. 5
  6. 6. History of 5-year Treasury Note Yields – Yield changes over time 6
  7. 7. History of Yield Curves – Yields on 2 and 10-year US Treasuries – changing shape of the curve 7
  8. 8. Indices of yield spreads for BBB (blue) A (yellow), and AA (red) rated bonds 8
  9. 9. Your Company’s Investment Process Consistent Investment Results REQUIRE a Consistent Investment Process 9
  10. 10. What to Watch For in the Near Future Greater Emphasis on Risk Management, because Uncertainty Will Grow not Subside Over Time Look for hidden risk. It’s there, but not being discussed to any great degree. Consider the ‘next shoes to drop’ Linked Effects of Investments – ‘Hidden’ Correlations Continued Politicization of Accounting Continued/Increased Board Interest in the Investment Process Expect to Hear More of ‘We’ve Never Seen This B f E tt H M f ‘W ’ N S Thi Before in O i Our Lifetimes’….Is Your Company Prepared? 10
  11. 11. What Are Your Company’s Key Investment Issues? Risk v Reward Reconsiderations? Yield v Total Return? OTTI Evolving? Accounting Tail Wagging the Investment Dog? Rating Agency Scrutiny? ERM/DFA – Lip service versus Reality? Board/Senior Management Politics? Other? 11