Secrets Of Success: Fewer happy returns in 21st century

Ned Cazalet, the life insurance industry analyst, had some good cracks in his presentation at the annual conference for directors of investment trusts this week.

Ned Cazalet, the life insurance industry analyst, had some good cracks in his presentation at the annual conference for directors of investment trusts this week.

It was cheeky, I thought, but effective, to use two pictures of the footballer George Best. One was taken in his heyday as a player; the other was a more recent shot showing the ravages of years of booze and excess. The idea was to underline the force of the regulator's favourite slogan - that "past performance is no guide to the future".

But there was nothing light-hearted about Cazalet's main message, which was uncompromising in its analysis of how all investment institutions are having to change their approach in the light of the new realities of investment in the 21st century. This, he pointed out, is a period when investment returns are going to be much lower than in the recent past.

Investment institutions of all kinds will most likely continue to be squeezed by a painful combination of unhelpful developments - falling returns on equities and other asset classes, low bond yields and tighter regulation, to name but three.

These developments have already put a painful squeeze on the free capital of with-profits funds, and forced a number of the big industry players to abandon the with-profits business. The free capital of life companies fell from £130bn to more or less nothing at its low point in 2003, Cazalet calculates, though it has revived a little since.

It is no accident that even the biggest players, such as the Prudential and Legal & General, have recently felt the need to raise new capital through rights issues. The shake-out in the industry may appear to have slowed a little, with the arrival of new entrants competing to buy the assets of some closed with-profits funds, but Cazalet is confident that the game is not yet over.

Putting two life companies together rarely proves a success, in part because the information systems of competing players are so often incompatible (if they work at all). The reality is that the amount of cash that the industry is having to pay out each year is less than it takes in as income, so the sector in aggregate is, in effect, shrinking.

That, you might argue, is capitalism for you, and not necessarily a bad thing. What is more worrying for investors, however, in Cazalet's view (and it's one I share), is that the new environment is driving the industry to change its investment policy quite radically, with far-reaching consequences for investors.

Insurers are slashing their equity holdings and are casting around desperately for returns elsewhere, not on any fundamental assessment of valuation or investment merit, but merely to meet tougher new regulatory requirements and manage their cash flows.

Most recently, this has driven them wholesale into buying fixed-interest securities, and corporate bonds in particular, often at prices that seem to take little if no account of the underlying risk. There will, no doubt, be a bill to be picked up in due course for this profligate behaviour. Bad things do happen in financial markets, and ignoring or mispricing risk, as many institutions appear to be doing, must catch up with you in the end.

The regulators' requirement that life companies must now provide more fully for guarantees they offer policyholders, and factor in the effect of volatility, is only the latest headache facing the industry. It is, of course, legitimate to wonder why life companies and their now-so-active regulators were not a little less complacent in anticipating some of these changes during the long years of the bull market, when preventive action could have been taken earlier.

However, I thought that Cazalet's most potent observation was that nearly all the problems that the life companies have been so publicly experiencing in the past five years hold true for pension funds as well. Final salary schemes, as we know, are being closed all over the place as the cost of providing for expensive future benefits becomes more visible. But this is only the tip of the iceberg of a range of big issues - including increased life expectancy and ageing populations - which are belatedly exercising pension fund trustees.

The difference from the life companies is that while they face the same investment issues, pension funds have no solvency regime, and the way they are run and controlled is full of ambiguity. The spectre Cazalet raised in his presentation is of a sector drifting towards a painful crunch, with little in the way of coherent direction. The only thing that is clear is that it will be taxpayers and employees who have to pick up the bill for all the future promises that have been made, but not fully provided for. For public sector pensions in particular, the bill will be a massive one.

Inflation

One thing that might ease the pressure on insurance companies and pension funds would be a return to inflationary conditions. One of the charts Cazalet used in his presentation is one I also use, showing graphically how real rates of return on equities, as measured by their rolling 10-year returns, have fallen steadily for two decades.

The reason, of course, is the success of anti-inflationary policies around the world, which have driven both actual and expected inflation to levels that would have been thought inconceivable a generation ago.

The question of whether what comes next is renewed inflation, deflation or more of the same is central to everyone's financial future, professional and amateur alike. That in turn brings us back to the question of who succeeds Alan Greenspan as chairman of the Federal Reserve when his third term of office comes to an end at the end of this year.

The decision, points out Andrew Teufel, research director at the private client firm Fisher Investments, could have potentially far-reaching consequences for investors.

His firm is bullish about prospects for equities this year, for much the same reason as Bill Miller of Legg Mason, whose views I quoted a couple of months ago (you can find links to both Cazalet's and Fisher's views on my website, www.intelligent-investor.co.uk).

Most of the obvious worries for equity investors - such as oil prices, the dollar, budget deficits - Fisher thinks are already priced into the market. But one concern that cannot yet be priced in is the risk that President Bush makes a quixotic or even disastrous appointment to the Federal Reserve, and that - judging by his track record of past appointments - is not something that can be readily discounted.

jd@intelligent-investor.co.uk

Sport
Thiago Silva pulls Arjen Robben back to concede a penalty
world cup 2014Brazil 0 Netherlands 3: More misery for hosts as Dutch take third place
Sport
Robin van Persie hands his third-place medal to a supporter
Van Persie gives bronze medal to eccentric fan moments after being handed it by Blatter
News
Ian Thorpe had Rio 2016 in his sights
people
Life and Style
Swimsuit, £245, by Agent Provocateur
fashion

Diving in at the deep end is no excuse for shirking the style stakes

PROMOTED VIDEO
News
scienceScientists have developed a material so dark you can't see it...
News
Monkey business: Serkis is the king of the non-human character performance
peopleFirst Gollum, then King Kong - now the actor is swinging through trees in Dawn of the Planet of the Apes
Arts and Entertainment
Blackman: Landscape of children’s literature does not reflect the cultural diversity of young people
booksMalorie Blackman appeals for a better ethnic mix of authors and characters and the illustrator Quentin Blake comes to the rescue
Voices
Mrs Brown's Boy: D'Movie has been a huge commercial success
voicesWhen it comes to national stereotyping, the Irish know it can pay to play up to outsiders' expectations, says DJ Taylor
Arts and Entertainment
Curtain calls: Madani Younis
theatreMadani Younis wants the neighbourhood to follow his work as closely as his audiences do
Life and Style
Douglas McMaster says the food industry is ‘traumatised’
food + drinkSilo in Brighton will have just six staple dishes on the menu every day, including one meat option, one fish, one vegan, and one 'wild card'
Life and Style
Once a month, waistline watcher Suran steps into a 3D body scanner that maps his body shape and records measurements with pinpoint accuracy
techFrom heart rates to happiness, there is little this fast-growing, self-tracking community won't monitor
Sport
Mario Balotelli, Divock Origi, Loic Remy, Wilfried Bony and Karim Benzema
transfersBony, Benzema and the other transfer targets
News
Soft power: Matthew Barzun
peopleThe US Ambassador to London, Matthew Barzun, holds 'jeans and beer' gigs at his official residence. He says it's all part of the job
Sport
Joe Root and James Anderson celebrate their record-beaking partnership
cricketEngland's last-wicket stand against India rewrites the history books
News
Gavin Maxwell in Sandaig with one of his pet otters
peopleWas the otter man the wildlife champion he appeared to be?
News
Rowsell says: 'Wearing wigs is a way of looking normal. I pick a style and colour and stick to it because I don't want to keep wearing different styles'
peopleThe World Champion cyclist Joanna Rowsell on breaking her collarbone, shattering her teeth - and dealing with alopecia
Finacial products from our partners
Property search
Have you tried new the Independent Digital Edition apps?
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

ES Rentals

    iJobs Job Widget
    iJobs Money & Business

    Information Security Manager (ISO 27001, Accreditation, ITIL)

    £70000 per annum: Harrington Starr: Information Security Manager (ISO 27001, A...

    Biztalk - outstanding opportunity

    £75000 - £85000 per annum + ex bens: Deerfoot IT Resources Limited: Biztalk Te...

    Trade Desk Specialist (FIX, Linux, Windows, Network Security)

    £60000 per annum: Harrington Starr: Trade Desk Specialist (FIX, Linux, Windows...

    Service Desk Analyst (Windows, Active Directory, ITIL, Reuter)

    £35000 per annum: Harrington Starr: Service Desk Analyst (Windows, Active Dire...

    Day In a Page

    Iraq crisis: How Saudi Arabia helped Isis take over the north of the country

    How Saudi Arabia helped Isis take over northern Iraq

    A speech by an ex-MI6 boss hints at a plan going back over a decade. In some areas, being Shia is akin to being a Jew in Nazi Germany, says Patrick Cockburn
    The evolution of Andy Serkis: First Gollum, then King Kong - now the actor is swinging through the trees in Dawn of the Planet of the Apes

    The evolution of Andy Serkis

    First Gollum, then King Kong - now the actor is swinging through the trees in Dawn of the Planet of the Apes
    You thought 'Benefits Street' was controversial: Follow-up documentary 'Immigrant Street' has got locals worried

    You thought 'Benefits Street' was controversial...

    Follow-up documentary 'Immigrant Street' has got locals worried
    Refugee children from Central America let down by Washington's high ideals

    Refugee children let down by Washington's high ideals

    Democrats and Republicans refuse to set aside their differences to cope with the influx of desperate Central Americas, says Rupert Cornwell
    Children's books are too white, says Laureate

    Children's books are too white, says Laureate

    Malorie Blackman appeals for a better ethnic mix of authors and characters and the illustrator Quentin Blake comes to the rescue
    Blackest is the new black: Scientists have developed a material so dark that you can't see it...

    Blackest is the new black

    Scientists have developed a material so dark that you can't see it...
    Matthew Barzun: America's diplomatic dude

    Matthew Barzun: America's diplomatic dude

    The US Ambassador to London holds 'jeans and beer' gigs at his official residence – it's all part of the job, he tells Chris Green
    Meet the Quantified Selfers: From heart rates to happiness, there is little this fast-growing, self-tracking community won't monitor

    Meet the 'Quantified Selfers'

    From heart rates to happiness, there is little this fast-growing, self-tracking community won't monitor
    Madani Younis: Five-star reviews are just the opening act for British theatre's first non-white artistic director

    Five-star reviews are just the opening act for British theatre's first non-white artistic director

    Madani Younis wants the neighbourhood to follow his work as closely as his audiences do
    Mrs Brown and her boys: are they having a laugh?

    Mrs Brown and her boys: are they having a laugh?

    When it comes to national stereotyping, the Irish – among others – know it can pay to play up to outsiders' expectations, says DJ Taylor
    Gavin Maxwell's bitter legacy: Was the otter man the wildlife champion he appeared to be?

    Otter man Gavin Maxwell's bitter legacy

    The aristocrat's eccentric devotion to his pets inspired a generation. But our greatest living nature writer believes his legacy has been quite toxic
    Joanna Rowsell: The World Champion cyclist on breaking her collarbone, shattering her teeth - and dealing with alopecia

    Joanna Rowsell: 'I wear my wig to look normal'

    The World Champion cyclist on breaking her collarbone, shattering her teeth - and dealing with alopecia
    Bill Granger recipes: Our chef gives raw ingredients a lift with his quick marinades

    Bill Granger's quick and delicious marinades

    Our chef's marinades are great for weekend barbecuing, but are also a delicious way of injecting flavour into, and breaking the monotony of, weekday meals
    Germany vs Argentina World Cup 2014 preview: Why Brazilians don't love their neighbours Argentina any more

    Anyone but Argentina – why Brazilians don’t love their neighbours any more

    The hosts will be supporting Germany in today's World Cup final, reports Alex Bellos
    The Open 2014: Time again to ask that major question - can Lee Westwood win at last?

    The Open 2014

    Time again to ask that major question - can Lee Westwood win at last?