Captives should not panic near end of cycle but might consider ‘removing some chips from the table’

As the US economy potentially reaches the end of a cycle and interest rates start to rise, captive owners should not panic – but they might consider “taking a few chips off the table”.

This was a view given in the panel ‘Economic Headwinds and Tailwinds Impacting Captives’ at the VCIA annual conference in Burlington, Vermont. Speakers included Scott Mildrum, economic and macro strategist at Performa (US) and Jeffrey Carr, president and senior economist at Economic & Policy Resources.

Mildrum advised captive owners that every situation is different, but in anticipation of the end of a business cycle, they must practice discipline, that it’s not the time to chase returns, and that market timing is not a winning strategy.

“A common saying in the industry is that if you’ve seen one captive, you’ve seen one captive,” he said.

Mildrum added that a thoughtfully designed investment policy statement (IPS) and a well-constructed portfolio should provide scope to manager through the later stages of the business cycle.

He advises captive owners to be cognizant of interest rate risk, and to begin to take a more defensive position with respect to risk assets.

“We are recommending captives taking a few chips off the table as far as flows are concerned,” said Mildrum. “When it gets to be late in the cycle, when the market starts to get a little jittery, you think about taking risk off the table.”

The panel examined the health of the economy, macroeconomic themes, global monetary policy and the overall direction of interest rates. It noted that the US economy is improving and the Federal government has embarked on a series of interest rate hikes in recent years.

Since the end of the recession, US economic growth has averaged 2.2 percent year-on-year, according to the US Bureau of Economic Analysis.

Some of the tailwinds included solid job creation, however below average job growth was a bit of an issue. The panel also cited a Wall Street Journal survey of economists in mid 2018 where only 17.7 percent of economists believed the US will have a recession within the next 12 months, down from mid 2016 where the figure was 21 percent.

Headwinds included the percentage of exports affected by retaliatory tariffs, and the forecasted publicly held debt outstanding as a percent of GDP, rising from just under 80 percent in 2016 to over 120 by 2040.