- Director of Global Investment Strategy for Barclays Wealth
“Negative real returns, low interest rates, counterparty risk and rising inflation are some of the difficulties captives face today.”
Having joined Barclays in 1998, Henk Potts is now Director of Global Investment Strategy for Barclays Wealth. Working across a range of jurisdictions, Henk analyses a wide variety of asset classes, from equities to commodities, as well as ascertaining and explaining the effects of macroeconomic changes on financial markets.
The dilemma for captives is that they hold large cash balances that must be kept liquid in order to satisfy future claims. Captives are a very unique entity. Because they self-insure, they build up significant cash balances as a result of incoming premiums. And as they assume risk on the liability side, they are reluctant to assume risk on assets. But keeping large cash balances not only results in minimal returns, it also exposes captives to other problems associated with cash. This wasn’t a problem when interest rates were much higher. Assets used to work harder to generate returns and in most instances the returns were sufficient to pay for the running cost of the captive. In 2008, for example, returns were in excess of 5%. But the current environment is challenging. Negative real returns, low interest rates, counterparty risk and rising inflation are some of the difficulties captives face today. Liquidity is also an issue, with captives being forced into longer-term fixed deposits in order to pick up yields. What’s more, despite negligible returns on assets, captive costs are increasing. So it begs the question of how some of these issues can be resolved.
How do you see the industry moving forward?
I see the solution as lying in matching liability and assets, and separating the assets into strategic and core operating cash. We know that core cash must be kept liquid but strategic funds could be deployed in the longer term – in excess of 12 months, for example. Specific investment solutions, such as money market structures, fixed income and various fixed income mandates, also have the potential to alleviate these issues and we can deliver bespoke structures to help, too. It’s rare for captives to invest in equities and, having spent time with captives, we can see how they’re very much focused on the area of fixed income. However, there has been change. We’ve recently started to work with some clients to try and broaden their area of exposure. Although this doesn’t always fit with the mandate of the captive, it’s in order to gain what we see as stronger returns from equity markets in the longer term.
Do you see any difference between the European captive industry compared to the rest of the world – the US, for example?
I think captives the world over face the same underlying issues. In all captive environments returns on cash remain relatively low or even negative, especially in the developed world. Therefore the real challenge is for captives to broaden their traditional realm of investment. Captives are accustomed to dealing with cash and bonds, but the returns from these markets are so low at the moment that captives need to somehow try and make the cash work harder to get the returns they require. We’ve taken some clients into the high-yield space but this is a relatively new environment for some. In certain instances, we’ve been able to go one step further and work with captives to develop solutions. In Bermuda, for example, we worked alongside Barclays Wealth Americas to develop an equity type approach – an equity structure can reduce the downside risk but still give the client exposure to an asset class that we think will outperform in the long term.
Do you think this approach could benefit from being discussed with the parent treasury department as well as captive managers?
While you certainly have to work closely with captive managers, it may be necessary to go beyond and work alongside the treasury department too. You’ll find that a lot of the work we’ve been doing has been educational. Often those involved in the captive industry are not specialists in the investment arena, as they have always dealt in the traditional asset classes of cash and fixed income, but currently that’s proving a difficult environment in which to operate. Therefore I think part of our work is really engaging clients and educating both managers and treasury departments about their options beyond traditional asset classes. It’s a slow process but it’s informative, and we’re leveraging our expertise across Barclays to both educate clients and develop solutions that can be structured in order to meet the specific needs of captives. While it’s still a very bespoke process – each captive tends to be different, with different mandates and different time horizons – I think the solutions we’ve developed are important. They’re changing the industry in many ways, which is part of the challenge and part of the opportunity. As we work with more and more clients, the chance may arise to develop a more packaged solution for captives in general, although I believe each captive will always require an element of bespoke management.
Are there any other topics you feel would be of interest to a captive insurance audience?
I think it’s important to note that in terms of the global economy, the outlook is improving. In more general terms, we’ve been talking to a broad range of clients about the significant long-term risks of holding cash. The negative real returns and the threat of inflation make this an investment decision that will prove costly over time. Many are under the impression that choosing to hold cash doesn’t constitute making an investment decision, but it does – and what’s more, it’s a decision that’s likely to have negative consequences in the current environment. But the good news for many captives is that they can invest money over a longer period of time, which should allow them to gain exposure to the asset classes that are set to outperform in the long term. In the current wealth management space, we’ve been talking to our clients about betting on companies rather than governments and owning companies instead of lending to them. I believe these themes are applicable to captives too, even if they’re initially something captives are not particularly used to. Despite the fact it’s part of a captive’s remit to keep some funds very liquid, I would suggest that given both the development of certain structures and products and where we are in terms of the investment cycle, it’s time for captives to look further and wider at their investment options. There aren’t many beyond Barclays looking into these opportunities for captives – it’s an exciting time.