Riskier assets are better in the long-run for captives

Captive portfolios should always be constructed to reflect a captive’s own liabilities and risk appetite, which means they should also be open to investing in more risky assets, according to Neil Michael, executive director of investment strategies at London & Capital.

Michael explains that longer liabilities will likely have a higher exposure to riskier assets but they should also have the time horizon to withstand short-term volatility and benefit from cyclical upturns. Recent analysis by London & Capital has proved this can be a worthwhile strategy for captives.

“In a very low interest rate environment, such as we are currently in, many captives have been pushed out of cash and into higher returning assets in search of yield to pay operating costs and beat inflation.

“However, in the longer term riskier assets such as equities and high yield bonds will deliver a higher investment return, in the shorter term it is these assets that have been hit hardest by recent events.”

Against this backdrop of extreme volatility in the markets, London & Capital has looked at how captive portfolios have fared.

Looking at the question through the lens of the London & Capital Captive Indices, which reflect the asset allocation of captives with different liabilities and risk profiles, London & Capital found that the index with the highest equity weighting had the worst performance, but even here, although the S&P 500 index was down 11 percent, the index was only down by 3.77 percent, thanks to the positive contribution from High Grade Bonds.

Moreover, capping the maximum equity allocation at 30% also helped. The other Captive Indices fared much better due to their greater exposure to High Grade Bonds. “Ultimately, the Captive Indices did what they were supposed to do – enhance returns, and protect capital the most for those (same) captives that require access to their capital at short notice,” Michael said.

Turning to the future, Michael said that the main macroeconomic indicators suggest that the global economy is not travelling head-long into a recession: the US service sector is expanding at its fastest pace since before the financial crisis, oil prices are in the doldrums (supporting personal incomes and company profits), the yield curve is still positive (helping to boost banks’ profitability and their willingness to lend) and global company earnings are still growing.

“The equity market, in particular, although experiencing bouts of volatility as investors climb a wall of worry, should come back. Consequently, captives with riskier portfolios will see their investment values recover and ultimately prosper, but with bumps along the way,” he said.