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1. Getting a Grip on Key Investment Issues
Alton R Cogert, CFA, CPA, CAIA
President and Chief Executive Officer
September 16, 2009
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. 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. 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. 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
7. History of Yield Curves – Yields on 2 and 10-year US Treasuries –
changing shape of the curve
7
8. Indices of yield spreads for BBB (blue) A (yellow), and AA (red) rated
bonds
8
9. Your Company’s Investment Process
Consistent Investment Results REQUIRE a
Consistent Investment Process
9
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. 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