The keys to investment management


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The keys to investment management

  1. 1. An Educational Guide The keys to investment management | insure | invest | retire |
  2. 2. Contents 1 | MassMutual: the company 2 | Investment philosophy 3 | Portfolio management and asset/liability management 4 | Portfolio diversification 10 | Asset quality 11 | Liquidity 12 | Additional information
  3. 3. MassMutual: the company Massachusetts Mutual Life Insurance Company and its investment management is an essential factor supporting domestic life insurance subsidiaries (collectively, that trust. As recent history has confirmed, investment MassMutual or the Company) provide financial protection markets can be volatile, and it is reassuring for our policy- against life- and health-related risks and manage financial holders and clients to know that they can depend on assets. Established in 1851, MassMutual is recognized as a MassMutual products to provide for their financial security. high quality and financially secure provider of insurance As a mutual insurance company, we do not have sharehold- and financial products. The Company serves millions of ers. We operate for the benefit of our policyholders and policyholders and clients with a broad product line of life members. This allows us to take a long-term view when insurance, annuities, long term care insurance, disability investing and not to worry unnecessarily about short-term income insurance, investment products,* investment advi- fluctuations in asset values. We are long-term investors sory services,* and retirement plan services. concerned with meeting commitments that stretch far into the future. Our continued financial strength is a critical attribute supporting the value of our products and services. Our Our investment management expertise, which is integral to clients trust us with their long-term financial protection and the success of our company and our products, is drawn from our investment subsidiaries: Babson Capital Management LLC, which manages fixed income, commercial mortgage, and equity assets; Cornerstone Real Estate Advisers LLC, a MassMutual is judged to be among the strongest manager and adviser of commercial real estate; and safest life insurance companies in the world. Our OppenheimerFunds, Inc., one of the largest asset manage- reputation for financial stability is confirmed by ment companies in the United States; and Baring Asset financial strength ratings (which are subject to Management Limited, an equity and fixed income manager change) that are among the best in any industry. As whose global investment expertise and reach complement of April 1, 2010, these ratings for Massachusetts those of MassMutual’s other investment entities. Mutual Life Insurance Company, C.M. Life Insurance Company and MML Bay State Life Insurance You should be confident that the company providing you Company were: with financial services is strong and will be there to help you, not just now but well into the future. MassMutual • A.M. Best Company, A++ (Superior) offers that confidence so you can worry less about the future • Fitch Ratings, AA+ (Very Strong) and spend more time enjoying the present. A key reason you • Moody’s Investors Service, Aa2 (Excellent) can trust MassMutual is our approach to investing. • Standard & Poor’s, AA+ (Very Strong) *Securities, investment advisory and financial planning services are offered through qualified registered representatives of MML Investors Services, Inc., a subsidiary of MassMutual. 1
  4. 4. Investment philosophy Our investment philosophy is the set of key beliefs that rary holdings may have a lower yield, the rewards from guides investment decision-making for the General putting money to work in more reasonably priced “perma- Investment Account (GIA) asset portfolio, which supports nent” investments should provide greater long-term benefits many of our insurance and investment products. to policyholders and clients. We believe that one cannot consistently predict market We rely on our own analysis and experience rather than direction. We try instead to determine where value exists following the investment crowd: our long-term perspective across and within various asset classes based on fundamen- enables us to pursue the opportunities which may arise due tal, bottom-up analysis of individual investments and how to short-term market fluctuations while many investors stay they compare with alternatives in a risk/reward framework. on the sidelines. A value approach to investing means acquiring assets We believe that broad diversification within and across vari- believed to be undervalued with less downside risk than ous asset types is a key to successful investing and an comparable investments. In selecting investments for important safeguard against many investment risks. We purchase or sale, we rely on the credit, loan structuring, believe that diversification adds both strength and safety to valuation, and quantitative expertise of our seasoned invest- the portfolio. Strength comes from choosing the most ment staff to compare the tradeoff between the risks and attractive investments from the very broad array of opportu- potential rewards for different investments. We look for nities available, while safety is enhanced by being less margins of safety by capitalizing on market inefficiencies vulnerable to bad news that might affect a particular sector that may affect individual investments, sectors, or asset or issuer. Our largest credit risks are only a small fraction of classes. In this way, we seek to provide more consistent our assets. results over the long term. Finally, we must always be able to meet our commitments to We believe that MassMutual should be adequately paid for policyholders and clients as they arise. This is, after all, the the investment risks in the portfolio. If, in our judgment, reason the Company exists and a key purpose of investment investments with reasonable value are scarce in the market- management. Therefore we always have cash and readily place, we are willing to hold more liquid high quality instru- saleable securities that are more than sufficient to meet our ments like U.S. Treasury securities temporarily until more obligations to you even if extreme circumstances arise. attractive investments become available. While the tempo- 2
  5. 5. Portfolio management and asset/liability management At MassMutual, we manage the assets to be able to meet be a useful guide, we also do extensive scenario analysis of liabilities with a high degree of certainty while also provid- assets and liabilities to see the potential effects of severe ing competitive products. While all of the assets in the GIA stress events. support all of the liabilities, the GIA is divided into a We then take prudent steps to protect the portfolio from number of portfolios which are managed separately to those possibilities at a reasonable cost. Credit risk is support particular product liabilities. managed primarily through diversification across asset Managing a specific portfolio requires an understanding of types, industries and issuers. Interest rate risk is managed by the products supported by that portfolio and how those keeping the sensitivity of the assets and liabilities to liabilities might change in different economic and financial changes in rates closely aligned with one another, an market conditions. Understanding this dynamic enables us approach generally referred to as “asset/liability manage- to assess the risk tolerance of the portfolio and set invest- ment” or ALM. Prepayment risk is managed within accept- ment limits which help ensure that the liabilities will be able ranges and may be offset through various types of met. The asset portfolio is then structured to be optimal interest rate options. Liquidity risk is managed by maintain- relative to the liabilities while adhering to these limits. We ing liquid holdings sufficient to meet needs even in stress project liability cash flows for the products supported by liquidity scenarios. each portfolio, then construct an asset portfolio consisting At MassMutual, derivatives are used in the normal course of primarily of higher quality fixed income investments that is our investment activities, primarily to manage risks related tailored to the liabilities. to interest rates. Derivatives are instruments whose returns Investment risk management is a high priority. Investment are based on, or “derived” from, the performance of other risks include credit risk, interest rate risk, prepayment risk, securities or a market index. They include such widely used and liquidity risk. Credit risk is the risk of loss due to financial tools as futures, options, and swaps which are inte- default or late payment. Interest rate risk is the possibility of gral elements of a comprehensive investment risk manage- economic loss due to changes in interest rates. Prepayment ment program. Derivatives may provide additional return, risk is closely related to interest rate risk and occurs when offset asset or liability risks, or both. Some derivatives are borrowers repay or refinance their debts unexpectedly, forc- particularly useful for managing interest rate risk and ing investors to reinvest at lower interest rates. Liquidity MassMutual uses derivatives extensively for that purpose. risk is simply the risk that cash can’t be made available to Some derivatives may be combined with other investments meet obligations as they arise. We use sophisticated quanti- to mirror the economics of conventional bonds while also tative tools to help monitor and manage the various risks. providing additional return. Thus derivative use is a natural Risk assessment occurs in a number of ways to gain differ- outgrowth of both our risk-averse investment philosophy ent perspectives on how economic and financial market and our value-driven approach. MassMutual does not use changes may affect assets and liabilities. While history can derivatives for speculative purposes. 3
  6. 6. Portfolio diversification Our belief in the value of diversification leads us to consider Bonds and Bank Loans a broad range of investments for potential purchase. Most of Credit risk is the major risk managed through diversification the portfolio consists of public and private bonds, bank and there are several ways to look at how that risk is loans, commercial mortgages, residential mortgages, managed in the fixed income sectors of the portfolio. Some securitized investments, and short-term instruments. There major sectors have very little credit risk as well as good are also public common stock, private equity, real estate, liquidity, such as U. S. Treasury and agency debt. Municipal and other investments which have higher long-term and sovereign debt is supported by other domestic and expected returns. Thus MassMutual’s portfolio achieves a foreign governmental entities where the borrower often has balance across major asset types (as shown in the chart taxing power or revenue from a specific project which below) and it is also very well diversified within those types. supports the debt. For corporate issuers, the credit risk is closely tied to the financial strength of the borrower and to its industry. Since GIA holdings by asset type – December 31, 2008 competitors in the same industry are subject to many of the Statement Value % Total same risks, we try to diversify across many industries and Asset Type ($ Millions) GIA Assets avoid too much concentration in an industry (as shown in Short Terms and Cash1 $3,049 3.5% the table on page 5) or individual issuer. For example, only Public Bonds 31,928 36.0 Private Bonds 16,712 18.9 0.5% of GIA assets was invested in fixed income securities Preferred Stocks 135 0.2 of banks at the end of 2008 and only an additional 3.2% Unaffiliated Common Stocks2 275 0.3 was in other financial entities such as brokers, finance Partnerships and LLCs3 5,480 6.2 companies, leasing companies and other insurers. Our Mortgage Loans4 13,048 14.7 Real Estate Equities5 1,096 1.2 internal limits for individual issuers vary based on issuer Policy Loans 9,156 10.3 credit quality and are much stricter than the limits set by Other Invested Assets6 5,339 6.0 regulators. Another way to assess diversification is to look Subtotal: Cash and Invested Assets $86,218 97.3% at the size of the largest corporate issuer exposures (shown Other GIA Assets 2,391 2.7 in the table on page 6), both individually and as a group. Total GIA Assets $88,609 100.0% The largest long-term corporate bond issuer represents only 0.1% of GIA assets. The ten largest long-term issuers 1 Includes $203 million of cash 2 Includes $202 million of public common equity and $73 million combined are less than 0.9% of GIA assets. of private common equity/warrants 3 Schedule BA securities 4 Includes $2,938 million of residential mortgage pools 5 Includes $126 million of properties exclusively occupied by the company 6 Includes common stock of subsidiaries and affiliates, derivatives and receivables for securities 4
  7. 7. Diversification of GIA fixed income securities (including short-term investments) – December 31, 2008 Statement Value % GIA Fixed Sector ($ Millions) Income Securities % Total GIA Assets U.S. Treasury $6,217 12.1% 7.0% U.S. Agency 3,152 6.1 3.6 Municipal/Sovereign 1,166 2.2 1.3 Mortgage-Backed Securities – Residential 10,783 20.9 12.2 Mortgage-Backed Securities – Commercial 3,817 7.4 4.3 Asset-Backed Securities 2,204 4.3 2.5 Investment Funds 1,282 2.5 1.4 Other* 1,493 2.9 1.7 Corporate Credit (by Industry) Banks 473 0.9 0.5 Capital Goods/Construction 2,925 5.7 3.3 Conglomerates 31 0.1 0.0 Consumer Goods/Cyclical 1,012 2.0 1.1 Consumer Staples/Services 3,328 6.5 3.8 Financial 2,806 5.4 3.2 Healthcare 822 1.6 0.9 Media 856 1.7 1.0 Natural Resources 2,231 4.3 2.5 Real Estate/REITs 1,269 2.5 1.4 Retail 594 1.1 0.7 Technology 655 1.3 0.7 Telecommunications 416 0.8 0.5 Transportation 674 1.3 0.8 Utilities 3,280 6.4 3.7 Total $51,486 100.0% 58.1% *Holding company debt The portfolio also has holdings in various types of securi- the collateral to different classes of investors according to tized assets. These represent interests in large diversified complex rules. Thus the priority of an investor’s claim on pools of collateral whose cash flows support these obliga- the cash flows as well as the credit risk in the underlying tions. Some securitized assets are straightforward and collateral affects the payments an investor receives. We simply pass the cash flows from the underlying collateral believe that our ability to analyze the underlying collateral directly to the investors in proportion to their ownership. and model the possible cash flows in various scenarios give Others are more complicated and redirect cash flows from us advantages in evaluating such securities. 5
  8. 8. Collateral of the GIA’s securitized assets varies with addition to its direct commercial mortgage loans, the GIA Residential Mortgage-Backed Securities (RMBS) being the held $3.8 billion of CMBS of which 94% were rated AAA largest sector at $10.8 billion or 12.2% of total GIA assets at by the major rating agencies. Many of the holdings with year-end. Most of the RMBS collateral is “prime” residen- lower ratings are those we chose to invest in based on our tial mortgages, issued by Government-Sponsored detailed knowledge of the underlying collateral, which Enterprises (GSEs) or largely supported by GSE collateral. increased our confidence that those properties would “Alt-A” and subprime holdings, which have higher relative continue to produce cash flow more than sufficient to serv- risk, represented 3.8% and 1.8% of total GIA assets. ice the debt. Commercial mortgage-backed securities (CMBS) are The remaining securitized holdings are Asset-Backed supported by pools of commercial mortgages. Therefore Securities (ABS) which are supported by a variety of other they generally provide more diversified collateral and better collateral. These include collateralized loan obligations liquidity than mortgage loans made directly (such as those (CLOs) and collateralized debt obligations (CDOs) backed described in “Mortgage Loans” below). We take advantage by corporate bank loans and bonds which provide additional of our expertise in commercial mortgages and our ability to credit diversification through those underlying holdings. We analyze the underlying collateral to generate additional can monitor this collateral closely using our own propri- value for the portfolio in this sector. At the end of 2008, in etary system. There are also small amounts invested in vari- GIA’s ten largest long-term corporate bond obligors1 – December 31, 2008 2 Statement Value NAIC % GIA Fixed % Total Issuer ($ Millions)3 Quality Rating4 Income Securities GIA Assets Kayne Anderson MLP Investment Company $96 1 0.2% 0.1% Kayne Anderson Energy Return Fund 95 1 0.2 0.1 Bank of America Corporation 76 1 0.1 0.1 Wells Fargo & Company 75 1 0.1 0.1 Anheuser-Busch InBev 74 2 0.1 0.1 BNSF Railway Company 72 1 0.1 0.1 IBM Corporation 64 1 0.1 0.1 United Parcel Service, Inc. 64 1 0.1 0.1 Procter & Gamble Company 59 1 0.1 0.1 Union Pacific Corporation 58 1 0.1 0.1 1 Excludes loans to affiliated companies of MassMutual 2 This is not a recommendation to buy, sell, or hold any security, and securities of these issuers may or may not be held in the portfolio at the time you receive this brochure 3 Exposure is net of credit default swap protection where applicable 4 Average ratings where applicable 6
  9. 9. ous types of receivables. While it is true that market values income investments totaled approximately $5.8 billion, or for many securitized assets have fallen due to greater-than- 6.6% of GIA assets. Investments in Canada represented usual uncertainty over their future cash flows in this difficult $0.8 billion of this total. Our foreign bond holdings by economic environment, we believe that significant value region are shown in the table below. will be recovered over time. Limiting risk to an industry or a single company in this way makes good sense. It is not easy to achieve such broad GIA international bond diversification – By geographic region – December 31, 2008 diversification and still remain selective in our investing, but Statement Value % Total we believe the effort is worthwhile. We actively seek Region ($ Millions) GIA Assets smaller institutional borrowers, many of which might not Continental Europe $2,317 2.6% have the size to access the public markets. We also include United Kingdom 1,286 1.5 foreign borrowers and borrowers that use vehicles other Australia/New Zealand 952 1.1 Canada 769 0.9 than conventional fixed rate debt. For example, our signifi- Asia 180 0.2 cant presence in the U.S. and European bank loan markets Latin America 15 0.0 provides access to issuers and attractive investment opportu- Other 289 0.3 nities that we might not otherwise see. International fixed 7
  10. 10. Mortgage Loans mortgage-backed pass-through securities, but are issued Approximately $10.1 billion of our $13.0 billion of direct privately rather than by a GSE. As a result, they have higher investments in Mortgage Loans are commercial mortgage yields which add value to the portfolio. Approximately 99% loans on buildings such as offices, apartments, shopping of the loans in these pools have government support in the malls, and hotels. There was a total of 445 loans at year-end form of either mortgage insurance from the Federal which are well diversified both by geographic region and by Housing Administration or a guarantee from the property type to limit the impact of a regional economic Department of Veterans Affairs. downturn or a broad slump in a particular type of property. The ten largest loans were collateralized by portfolios of Equities and Real Estate properties rather than a single property. The ten largest Common equity is an asset class that can provide good loans that were collateralized by a single property ranged in long-term returns to the portfolio as well as additional diver- size from $58 million to $85 million and totaled $686 sification. MassMutual holds common equity in various million at year-end, or less than 0.8% of GIA assets. forms, including public common stock, private equity part- nerships and LLCs, equity funds, and warrants. Private The remaining $2.9 billion of Mortgage Loans is residential equity, which makes up most of the equity portfolio, has mortgage loan pools which are similar to publicly traded Commercial mortgage loan diversification* – December 31, 2008 Statement Value % Total Commercial Property Type # Loans ($ Millions) Mortgage Loans % Total GIA Assets Apartments 175 $ 2,841 28.2% 3.2% Hotels 25 701 6.9 0.8 Industrial 55 1,484 14.7 1.7 Office & Medical Office 144 4,007 39.6 4.5 Shopping Centers & Retail 36 803 7.9 0.9 Miscellaneous 10 274 2.7 0.3 Total 445 $10,110 100.0% 11.4% Statement Value % Total Commercial Geographic Region # Loans ($ Millions) Mortgage Loans % Total GIA Assets Northeast 52 $1,438 14.2% 1.6% Mid-Atlantic 46 957 9.5 1.1 Southeast 42 677 6.7 0.8 Midwest 79 1,405 13.9 1.6 Southwest 90 1,729 17.1 1.9 West 120 3,336 33.0 3.8 Canada 16 568 5.6 0.6 Total 445 $10,110 100.0% 11.4% * Excludes $2,938 million of residential mortgage pools 8
  11. 11. provided significant benefits to the portfolio over the years, has historically produced good cash flow. In addition, both directly through ownership in growing companies and MassMutual has investments in real estate funds, partner- indirectly through attractive lending opportunities that arise ships, real estate investment trusts (REITs), and REIT funds from these business relationships. Private equity provides which add diversification and, in the case of REITs, liquid- exposure to a variety of primarily middle-market businesses ity to the company’s real estate holdings. MassMutual’s real which may operate regionally, nationally, or outside the estate investments are actively managed to add incremental United States. value by Cornerstone Real Estate Advisers. Cornerstone has expertise in all major property types and regional offices The equity real estate portfolio, including some funds and which provide considerable strength to the organization and partnerships, totaled $1.9 billion at year-end, or 2.2% of keep it well positioned to manage the Company’s real estate GIA assets. Real estate holdings are diversified geographi- equity investments. Real estate has produced significant cally to insulate the portfolio from downturns in local or capital gains for MassMutual in the past and the actual regional economies. Currently most properties are offices value of the current portfolio is significantly greater than the and hotels, but this composition may shift to other types accounting values in the accompanying tables. over time in response to value in the marketplace. Commercial real estate provides certain tax advantages and Real estate equity diversification* – December 31, 2008 Statement Value** Property Type # Properties ($ Millions) % Total Real Estate % Total GIA Assets Apartments 28 $281 14.6% 0.3% Hotels & Motels 18 590 30.7 0.7 Office 22 583 30.3 0.7 Retail 11 155 8.0 0.2 Miscellaneous 29 316 16.4 0.3 Total 108 $1,925 100.0% 2.2% Statement Value** Geographic Region # Properties ($ Millions) % Total Real Estate % Total GIA Assets Northeast 20 $325 16.9% 0.4% Mid-Atlantic 23 377 19.6 0.4 Southeast 8 313 16.3 0.4 Midwest 11 124 6.5 0.1 Southwest 15 176 9.1 0.2 West 31 610 31.6 0.7 Total 108 $1,925 100.0% 2.2% * Schedule A real estate excluding Home Office properties of $126 million and including $955 million of Schedule BA assets ** Statement value is net of reserves, depreciation and debt 9
  12. 12. Asset quality Most of the GIA consists of fixed income securities. For these the legal protections in the contract. For example, MassMutual holdings, the National Association of Insurance Commission- has significant private placement holdings which, in addition ers (NAIC) has a six-tier quality rating system. Categories 1 to providing higher yields, generally offer some combination and 2 are investment grade, Category 3 holdings are consid- of superior financial covenants and better call protection ered to be medium quality, and Categories 4 through 6 are features versus comparable public bonds. These provisions are lower quality. The table below indicates how NAIC categories designed to protect MassMutual’s interests as an investor. compare with ratings similar to those used by public rating These holdings also provide additional diversification since agencies and shows how MassMutual’s GIA fixed income they are often from industries and issuers different from those securities (including short terms) were rated as of December whose securities are available in the public markets. 31, 2008. Clearly, the vast majority of these holdings are high Unlike for fixed income securities, there are no industry quality. Category 3 holdings are often very good middle- standards for mortgage loan quality. We use an internally market companies that historically we have financed very developed, proprietary system to rate the quality of all successfully, but that have not achieved the size to be rated commercial mortgage loan investments. Each commercial Category 1 or 2. Our experienced fixed income analysts mortgage is reviewed at least annually under this comprehen- carefully monitor developments that may affect portfolio sive system by experienced mortgage loan analysts from our holdings and also utilize our own internal rating system rather network of regional offices. This regional office organization than relying solely on public ratings. The value of their allows associates to keep close watch on local market capabilities becomes even more apparent during periods of conditions and act quickly to conserve value in the portfolio by economic stress, such as that we are now facing, when credit working with troubled borrowers when required. problems are more likely to surface. MassMutual’s commercial mortgage loan portfolio performed The quality of portfolio holdings is more than the financial well during 2008. strength of the issuers; the quality of a bond may also rely on Quality of GIA fixed income securities (including short-term investments) – December 31, 2008 NAIC Rating Equivalent Rating Statement Value % GIA Fixed % Total Category Agency Designation ($ Millions) Income Securities GIA Assets 1 AAA, AA, A $35,207 68.4% 39.7% 2 BAA 12,270 23.9 13.9 3 BA 1,666 3.2 1.9 4 B 1,547 3.0 1.7 5 Lower Quality 577 1.1 0.7 6 In or Near Default 219 0.4 0.2 Total $51,486 100.0% 58.1% 10
  13. 13. Liquidity MassMutual maintains a strong liquidity position in keeping public bonds and short-term investments that can be sold with its commitment to clients to provide timely payment quickly and easily to satisfy policyholder and client needs if without forcing the sale of assets at distressed levels. Cash necessary. However, such sales are unlikely as the Company flow and liquidity needs are routinely addressed as part of has enjoyed strong positive cash flow in recent years. the investment management process. We also perform peri- Moreover, MassMutual has a $1 billion commercial paper odic liquidity stress testing that goes beyond regulatory program which permits it to borrow on a short-term basis requirements. That analysis of possible demands on port- for various corporate needs. While we do not rely on the folio liquidity under adverse scenarios confirms that the ability to issue commercial paper in liquidity planning, it Company continues to have a strong liquidity position. The adds to our financial flexibility. portfolio maintains a large share of its assets in high quality 11
  14. 14. Additional information MassMutual operates in an extremely competitive financial We hope you agree that MassMutual is a strong company. services marketplace. Our primary objective continues to be We welcome your comments and questions. Please direct maintaining the financial strength to fulfill our commit- any inquiries to your MassMutual representative or your ments to you, our policyholders and clients, over the long financial adviser, or feel free to submit them via our website term. In support of that goal, we will continue to pursue the at, which you can also explore for same value-driven investment philosophy that has served additional financial and investment information. you so well. 12
  15. 15. MassMutual. We’ll help you get there.®
  16. 16. © 2010 Massachusetts Mutual Life Insurance Company, Springfield, MA. All rights reserved. MassMutual Financial Group MS1003 410 is a marketing name for Massachusetts Mutual Life Insurance Company (MassMutual) and its affiliated companies and sales representatives. CRN201007-122464