Searching for the safe ground
Jeff Sangster, executive vice president and chief financial officer of Validus Group, has a saying that he believes encompasses his feelings about the period since 2008: “The hardest time to invest is now.”
“You look back and you can see what you should have done,” Sangster explained. “There are a thousand advisers who can tell you what the market will look like in a year or where they think it is going. Putting it all together and deciding where to put the money now is the most difficult part. Every investment environment has its challenges, but I don’t think it’s necessarily more challenging now.
“If you look back five years we were watching Lehman close and the markets melt down. We are in a more stable environment now, apart from the fact that a lot of what currently drives the markets is political.”
Political interference
The kind of political interference that Sangster sees is global. The US Federal Reserve is toying with the idea of drawing back on quantitative easing. In the eurozone it’s a battle of wills between north and south, with buzzwords like ‘austerity’ and ‘bailout’ still being bandied about, and Germany’s chancellor is up for re-election to boot. The European Central Bank has become a major power player in the global economy; it fl exes its muscles and the ripples are felt around an increasingly interconnected world, western and emerging economies alike.
"It's harder to take a stronger position in one direction because to a degree you're taking a bet on a decision that someone else is going to make."
“A lot of time is spent trying to surmise what the Federal Reserve is thinking, what the chairman is going to do and how that will evolve into the tapering programme which must occur eventually. The current environment is less technical. There’s more mindreading and psychology coming into it, which is always dangerous. It’s harder to take a stronger position in one direction because to a degree you’re taking a bet on a decision that someone else is going to make,” said Sangster.
It’s not just developed economies that are being affected. “This summer we’ve seen the impact on emerging markets. What’s happening in the US is having a knock-on effect to emerging markets and some markets that were formerly darlings are starting to struggle as a result. What happens with the US Fed is having a global impact in what is now such a connected worldwide economy. The US has sent the international markets into a tailspin by talking about tapering the amount that they’re going to buy, not even talking about cutting that number to zero.”
The situation is much the same in Europe, as what Sangster describes as “have and have not” countries grapple over bailouts, unpopular austerity measures and a generation of young people with no prospects. It’s a hotbed of political risk and unrest that Sangster feels ambivalent about.
He explained, “We’ve been extremely cautious around Europe for the last fi ve years because we believe that there may be an opportunity at some point, but right now political risk and the risk of politically driven decision-making is driving us away. Never in recent memory have we seen markets driven by decisions of individuals, as opposed to being driven by pure market forces.”
The secrets of success
Sangster hopes for the return of a data-driven market, but he’s very aware that success in the current environment can’t be found through quantitative analysis and hard numbers. It’s a nervous time for business leaders but there are, according to Sangster, steps that can be taken to prepare for the changes, shocks and instability that come with a politically-driven market. Companies can fi nd safe ground, Sangster said, but must keep an important lesson from 2008 in mind as they search for it.
“What’s been proven through the crisis and since is that risk-taking hasn’t been particularly well rewarded,” he said. “It’s too easy to be wrong when you’re betting on a political environment. Our approach has been to stay conservative. As a company we were founded on the idea that we are not a company that relies on our investment income to make a substantial portion of our profi ts.”
This point was hammered home for Sangster almost immediately. Directly after the global economic crisis kicked off in late 2008 there came a strong underwriting market on the back of Hurricane Ike. Sangster recalled some players with capital bases eroded by investment losses unable to take advantage of the strong underwriting environment at January 2009 renewals.
“Some of our competitors had to cut back or limit the amount they were able to take advantage of that opportunity because of what happened in their investment portfolios. As a CFO you don’t want to be the one telling your chief underwriting offi cers that they have to limit the amount of business they write in a good market because of something that happened in the portfolio. That’s a tough conversation to have.”
To avoid that diffi cult position (and equally diffi cult conversation) Sangster runs Validus with a very clear set of priorities. The number one goal of the company is to preserve capital so that it can channel that capital back into underwriting. Investment income is less of a focus for Sangster; instead, Validus focuses on writing profi table business and ensuring that enough capital is held for those teams to continue writing unhampered.
Validus Group’s second priority is to ensure it has enough capital held back to pay claims quickly. Liquidity is important to Sangster, a focus which is consistent with the company’s desire to financially support clients in the days immediately following a large loss event. Of those priorities, Sangster said, investment income is number three: “Yield is a distant third in that equation.”
This strategy has ensured that Validus always has capital to write business, but there are moments when the capital supply is—simply put—excessive. Sangster explained that a soft market means that there just isn’t enough desirable business to write, and his underwriters aren’t willing to compromise on their standards just to get all of their capital committed. In that situation, Sangster said, Validus makes it a point to return excess capital to its shareholders.
This year Validus has announced a $500 million share repurchase programme and increased its quarterly dividend from 25 cents to 30 cents. It also declared a $2 per share special dividend. “It’s a classic struggle between dividends and share repurchase. It’s an easy conversation when you’re trading below book value and can buy back your shares at a discount,” Sangster said of his decision.He continued: “It’s a bit of a high class problem once you start trading above book value in terms of determining to what point you continue to buy back shares and what that balance is between share buyback and dividends. Some of our peers in the London market trading at higher multiples exclusively use a dividend approach because buying back shares at a premium doesn’t make sense. We’re on that bubble now where we’re trading just above book value. We continue to buy back shares but also evaluate where dividends come into that equation.”
A conservative approach
While Sangster may believe firmly in returning excess capital to his shareholders, he does have an investment strategy designed to get Validus through these tumultuous times. A conservative investor, Validus has built a short duration portfolio, recently hovering around 1.7 years. This allows them to roll down the curve when interest rates inevitably go up, taking advantage of the higher rates.
Sangster also cited a bank loan portfolio as a major part of his strategy. Started two years ago it now accounts for around 10 percentof Validus’ portfolio at a group level. Sangster said, “We hold a large amount of corporate debt, and for the same reason we like those investments, we like bank loans. They’re not a fixed rate security— they’re floating. As rates increase, that 10 percent of our portfolio won’t see the marks that a fixed income portfolio would. We’ve always seen that as a hedge against higher interest rates. “These two approaches are how we’ve prepared for what seems to be the inevitable move in rates.
When the short end was at zero it seemed like an asymmetrical risk curve to us—they can’t get any lower but there’s a lot of scope for them to go higher. Trying to time that move up is a fool’s errand so we positioned ourselves conservatively.”
