Everybody for attending here the RBC Capital Markets 2019 Financial Institutions Conference day 2. I guess we're the opening act for the 2nd day. This is the 1st ever insurance investment panel. It's also the 1st time I've ever had a mixture of both life and P&C companies all on the same stage. Normally, we're so monolithic. We do life panels, we do P&C panels. We never really mix them together. The thesis here this morning was really all of these companies are investors. We spend a lot of time focusing on the right-hand side of the balance sheet. I thought we'd take the opportunity today to focus a little bit on the left-hand side of the balance sheet and the people who do so much to create value on that half of the equation. This morning, I'm joined by three panelists.
At the far end, we have Louis Marcotte of Intact Financial. He's the Chief Financial Officer there. Has been there in that role since 2012. Next to him in the center is Marty Hollenbeck. He's with Cincinnati Financial, Chief Investment Officer. Marty's been with Cincinnati Financial since the 1990s and moved into his current role about six or seven years ago. I think that's right.
Close.
To my immediate right is Ellen Cooper. She's been with Lincoln since 2012. She's the Chief Investment Officer there. With that, I think the format this morning, we'll start off, I'll give them each a minute or two to talk about themselves, their company, some investment style, whatever they want to say, to level set the playing field. We'll jump into some questions that I have. We'll take some questions from you all, and we'll try to make this as interactive as possible. It's a room full of investors talking about investments. It ought to work, right? Maybe we'll start off with Ellen.
Sure. Good morning, everybody, I am the Chief Investment Officer of Lincoln Financial. Lincoln is a 100% U.S. domestic life insurance company, for those of you not familiar, in 4 major businesses. We are in the annuity business, the life business, the retirement plan services business, and the group protection business. I oversee close to $300 billion now of assets, $100 billion that are in our general account, then another $200 billion that are in our separate account that support our variable products. I'm going to spend most of my time and comments today on the general account, just broadly speaking, in that $100 billion of assets, we are putting on average around $12 billion of new money to work every year. As many of you know that are familiar with life insurance companies, we invest relative to our liabilities.
We have a disciplined, overall ALM approach to investing. We predominantly invest in high-quality fixed income assets. Then we have a unique model, and we'll get into talking about this a little bit more later. One of the things that is very unique about Lincoln as a U.S. life insurance company is that we primarily use external managers for security selection in our general account. We'll get to that more in later Q&A.
Awesome. Going straight down the line.
Good morning. Marty Hollenbeck, Cincinnati Financial. We are a Midwest-based top 25 P&C insurance company. We're about two-thirds commercial lines. We are known for our agent-centric model, independent agents. We have field folks who have a lot of autonomy. We believe in local decision-making. We have had a long, nice dividend streak of 58 consecutive years of dividend increases. We internally measure ourselves primarily by what we call the value creation ratio, VCR, which is basically is book value growth adding back our dividend paid. Then on the investment front, the distinguishing feature that we have is in a large cap, high-quality dividend growth strategy with ±50 core names, generally buy and hold, and that's served us well for a number of years, and we're about 35% equities.
All right. Louis Marcotte. Good morning, CFO at Intact Financial. We are Canada's largest P&C insurer. Over a year and a half ago, we made our first foray into the U.S. marketplace buying a company called OneBeacon, so about 15% of our business now is in the U.S. It's about CAD 10 billion of annual premiums. For simplicity, let's multiply that by 0.7 to convert into U.S., so about $7 billion. In terms of P&C premiums, our asset portfolio amounts in total to about CAD 20 billion, so about $14 billion. Our mix, a bit similar to yours I guess, we are also somewhat equity focused but still an 80/20 mix fixed income to equities. We have a fairly large preferred share portfolio which is oriented towards dividend income.
Cross-border, we report under IFRS, which is slightly different and brings in a bit of a twist because that pushes us to discount liabilities on the right side of the balance sheet which makes for a different management of interest rate risk. The cross-border, of course, brings a few complexities, as you can imagine, whether it's capital, it's tax, which is fairly new to us now, and we've had a year and a half to get used to it, but it brought some advantages to our management of the portfolio and diversification to a couple of currencies.
That will be my introduction for today.
Okay
The rest later.
Very good. I think when I was putting together this panel, I was doing this back in December or early January, so I suppose top of mind for me, and maybe top of mind for a lot of people in the room, was the question, the topic of credit quality. I think my phone rang every day with somebody saying, "Who's going to get killed the most when credit quality goes to the basement?" Everybody sort of immediately imagined that there's no in-between point between a booming economy and 2008 all over again. Let me put it to the group, just how are you thinking about credit quality? What are you doing to position your portfolios? How do you monitor credit amongst some of the holdings? A few thoughts on how that's positioned. Maybe, Ellen, we'll start with you.
Obviously, we have a pretty significant fixed income portfolio where we are long credit. Using our external managers for us is a real driver of being able to have multiple lines of defense as it relates to credit risk management. In public credit, for example, we have more than one manager that is covering the same name, and they are, first of all, providing information for us, analysis, stress testing at the name level. What we often see is that managers don't necessarily agree with a particular situation. We internally also have an internal team of very experienced people with 25+ years of fixed income research experience.
We put all that together, and we are overseeing the entire portfolio name by name, evaluating those particular credits where we have a concern that under a stress scenario, under a credit cycle scenario, either the position size should be smaller or we should be reducing the position size. We have, since the end of 2015, as the credit cycle continues to extend, we do think that there's plenty of room for the credit cycle to continue, by the way. We have reduced $3.5 billion, de-risking $3.5 billion of credit securities that had the potential to deteriorate under stress. Additionally, we do significant name-by-name stress testing at the total portfolio level.
We don't think that we're going to see a repeat of 2008 verbatim, we prepare ourselves to make sure that we're comfortable that in a tail scenario, that we are comfortable with potential credit losses, that we understand where the potential risks are. We're constantly looking across factors, et cetera. The final thing is that we also, as we're putting new money to work, we also have been tilting toward more defensive sectors. We're using that to also drive the portfolio to be positioned somewhat more defensively, while also proactively de-risking in particular names that we think could be under stress in a credit cycle.
I think that's interesting about having the multiple managers, how that gets you some kind of incremental perspective. A lot of times, I know just investors I talk to, people tend to be lone rangers out there as far as thinking about things, their thought process is as rigorous as the number of opinions that they can find. I think that's an interesting perspective to have to be able to, play off isn't necessarily the right word, but at least benefit from the thoughts and experience of multiple, probably all very smart managers.
Exactly. To bring it back home and to have an internal view of people with a lot of experience that have been through multiple credit cycles to say, "Manager one said this, and this is what they are thinking. Manager two said this, I think this." We put it all together, and we ultimately decide whether or not to take an action. This has worked extremely well for us. Case in point, during energy back in early 2016, we went through this disciplined approach, and we were very successful in execution of de-risking in areas where we just wanted to have less exposure and with pretty minimal losses.
Okay. Good thought. Marty, how about next?
Yeah. We have about, say, 32%, roughly a third of our entire portfolio in investment-grade corporate bonds with an average rating of about triple B plus. Credit is certainly significant in our portfolio. We also are in a position where our fixed income portfolio, as in total, it's about 126% of our insurance reserves. We feel like we have some cushion there. We tend to invest more for income than total return and not concern ourselves too much with quarterly mark to market. Now, the reality of credit spreads widening out as they did last year, I think about 60 basis points, depending on how you measure it. We've got about half of that back this year, I think. The disconnect between what the market signals and ultimate default rates can differ. They did somewhat in 2008-2009.
We tend to look at it from the bottom up, generally sector-specific. We have four professionals dedicated to the investment-grade portfolio. The last time I think that we really had to do significant pruning for credit reasons was, as Ellen mentioned, in 2016 in the energy sector. We took some hits there. By and large, unless we see real deterioration in certain credits, we do not act. We'll generally hang on to the bond. Beyond that, it tends to swing. We will oftentimes use sell-offs as buying opportunities if we see we have confidence that they're money good. By and large, we don't sweat the quarterly mark-to-market situation.
I think that's another interesting aspect of most insurance portfolios. People are generally holding to maturity. Unless there's ultimately a default or an actual impairment, the market swings. Yeah, nobody likes them, but the fact is you can ride them out. You're driving in cash flows literally every day. Unlike some of our investors in the group, you don't have net outflows very often. In fact, it should be the rare situation. Being able to kind of ride it through or use the opportunities, that's an important part of the equation.
Absolutely, you're right. I hope we don't have ongoing outflows. We manage a bit the same way as you do. We don't sweat the quarterly. The portfolio structure is really the starting point. I would say 92% of our bonds are A+ or A and above on average. We tend to take a bit less credit, and one reason for that is we're heavily invested in preferred shares. The structure of our portfolio, again, I mentioned, driven towards investment income and driving operating earnings. Therefore, we take a bit more risk on the equity side, preferred equity. Because of that, we sort of reduce the fixed income risk. Really, the portfolio structure is really the starting point for us. Then we monitor, obviously, credits, specific credits or sector credits, ongoing, and monitor the main indicators.
In our case, recently in Canada, I guess housing has always been sort of headline news. Not that we have an overall concern over it, but we are watching the leverage of consumers as an example. Obviously, spreads. In the U.S., we're watching more the leverage of commercials. What's been interesting for us, if you're based in Canada, you're very quickly concentrated in the financial sector because if you want to generate dividends or interest income, the biggest issuers are obviously the banks and the life cos. Over time, we've chosen to diversify into the U.S. to build a fixed income portfolio on the U.S. side, which gave us a lot more diversification in terms of sectors. We did a bit the same on the equity portfolio. This was really fruitful from a diversification point of view and getting away from financials and government bonds.
We were heavily invested in government bonds. Again, very focused on a Canadian economy. Going into the U.S. allowed us to diversify into the currency and into more sectors which helps in terms of managing our credit risk.
Yeah. I guess amongst the panel, you have kind of a unique position of you're multinational. These two are primarily domestic. Although Cincinnati is working to change that. Likewise, just the Canadian marketplace being relatively smaller, yeah, you'll have to get some diversification from somewhere. Otherwise, you end up owning proverbially all the mining and bank stocks, and that's not very diversified.
Energy.
Energy, yeah. Energy too. RBC guy forgetting about energy. How could I do that? Okay. Maybe we'll move on from credit quality to kind of the other thing that we saw in December, which was really just plain old volatility. There's a lot of different aspects, again, to managing volatility. Maybe talk about where within your portfolio you have the greatest concerns about that, what you do to manage, monitor. Same sort of question. Maybe this ends up being a little bit less tuned to your fixed income portfolio, a little bit more tuned to the non-fixed income portfolios, since we kind of already covered that on the first one. Marty, why don't we start with you on this one?
Well, that obviously volatility hits home for us with over a third of our portfolio in common stocks. Fourth quarter was difficult. Worst quarter, I believe, in the market since the third quarter of 2011. It's been a while. Ultimately, we choose our risk tolerance level, set it there, and that has changed over time. You go back prior to the financial crisis, we were actually higher by a fair amount in common equities. We repositioned the portfolio, so we understand fully. Again, the mark to market quarterly issue is not to say it's not of concern, but we understand it will happen. We've had a nice ride for the last 10 years. As bad as fourth quarter was, so knock on wood, first quarter's done well.
So far so good.
So far so good. As I mentioned, there's an income aspect to our equity investing. The dividend received deduction, while not as attractive as it was prior to the tax change, still nonetheless is compelling for us at about a 10.5% at the corporate level. We buy companies that pay consistent dividends, grow those dividends. We always have that to fall back on the income statement impact of our equity investing. Again, similar to what I mentioned with bonds, market selloffs can provide opportunity for us to build out positions or get in new names. We have around 50 core names, as I mentioned, diversified fairly well across sectors. It will happen.
Again, you pick your risk tolerance, you set it, you understand that every so often it's going to get out of whack a little bit, you hang on, ultimately over the long run, which we gear everything in the corporation to the long term, it pays off.
I always thought that's one of the neat things about your portfolio is that you guys were dividend investors back before dividend investing was cool. As a result, you end up with a portfolio yield that has equity upside to it, but really with a net investment income return or net investment yield, whatever way you want to say it, that really resembles some of your peers that are just doing plain old fixed income. It's kind of a nice position to be in that you get the upside of the markets as well as still bringing across the plate good NII.
Mitch, from near the founding of our company back in the early '50s, it's been the philosophy of our company to pursue a high-quality dividend growth strategy. It's worked through many markets. The early 2000s was a little tough. Obviously, '08, '09 was very difficult. We stick with it.
What do you guys do?
Again, I don't want to repeat here. We're a bit similar in terms of managing for dividend income. Let me focus a bit on volatility here. When we look at our risk appetite as well, managing volatility is important. The capital factors are impacted when the markets are moving significantly. This is an area that we monitor very closely. When we look at the different risk factors, for example, we say for 100 basis points of interest rate movements, our book value per share would move by less than 2%. That's an important aspect of limited risk of interest rate fluctuation. You'll remember my comment at the outset, because we discount liabilities, this is a natural hedge to the fixed income portfolio, hence the limited risk for interest rate volatility. You get into market risk.
A 10% move in the equities market would have about a 3% impact on our book value per share. We're fairly comfortable to absorb 3% impact on book value per share should the markets move by 10. We were hit by obviously the fluctuations in Q4 last year. We were negatively hit on our equity portfolio. The U.S. dollar actually strengthened against the Canadian dollar, which is an offset. There's a second natural hedge, which is the equities market in Canada actually tend to fluctuate in the opposite direction of the U.S. dollar. There's a second hedge, which limited the impact to our balance sheet and our capital position last year. This is part of the complexity now of managing across borders. I say complexity, but once you've mastered it, you can play it to your advantage.
We have currency now that's become a hedge to the equities market. Fundamentally in our asset portfolio structure, managing the sensitivities within this 2%, 3%, 5% range for us is acceptable. As long as we stay within this, we're happy to be there.
Your first comment was interesting. I'm going to have to actually spend some time looking at how in the life insurance, we're looking forward a few years where companies are going to need to adopt a more IFRS-like accounting related to their assets and the liabilities. Right now, it's so imperfectly matched that the accounting itself creates its own volatility. Whereas you actually have the situation where it works, we'll say, as intended, that you get kind of the shock absorber effect on both sides of the balance sheet. I guess it creates some challenges, but it also creates a certain amount of flexibility because you don't get the capital pressure of only having half move and the other half being static. I'm going to have to spend some time studying the way that worked on your results.
Come and visit. We'll show you what it looks like.
Ellen, how about for you?
As it relates to equity market volatility in the general account, we're much less of a story as a life insurance company. The place where we are impacted, we have a small but important alternatives portfolio. It's about 1.7% of the overall general account. That is a place where we will see the equity market volatility. It's a highly diversified portfolio, and it's not directly correlated to public equity. We'll see some impact. And by the way, we have a one-quarter lag in our private equity, one-month lag for hedge funds, which are very small inside of there. We'll see some impact of that go in the first quarter, which we have talked about previously.
Additionally, we also have the ability to, when we see equity market volatility that is correlated with credit spreads wider, we also can opportunistically, when we believe the credit cycle is benign and that it's an overreaction, which we did, we can take advantage of that as well as we're putting money to work. We did achieve a very strong new money yield in the fourth quarter of 4.5%. That was about 20 basis points higher than the average that we had for 2018. That's another example for us of what we think about as the internal natural hedge as well, where spreads are wider. We get to take advantage of that during the same time that we've got some level of equity market volatility in our small but meaningful alternatives portfolio.
It reminds me actually kind of, I'll get the quote wrong, but Warren Buffett would always say the advantage of markets going down is there's a buying opportunity when you have assets to deploy, cash to deploy. You get a situation like last month, one person's fear factor is another person's opportunity if you have the right timeline and the right discipline to kind of get after it when things come your way. Anyway, before we go to the audience, I have one other topic I want to hit on. Just the whole question, and you brought it up at the very beginning, of kind of the in-house versus active versus passive versus external managers. I mean, kind of everybody has their own way to skin this cat.
There's obviously no right answer. Each of you has your own right answer. Maybe you can share that with me. Maybe Louis, start us off.
Sure. Thank you. In our case, we actually manage most of our portfolio in-house, 90% of it, essentially. The part that we have outsourced now is one we inherited from our acquisition in the U.S., which is an MBS, ABS portfolio. We are not experts at that, we left it outside. For the rest of the portfolio, fixed income, preferred shares, common equities, we manage that internally. The track record of the team is fairly strong over time. In our case, Intact is one company where the financial value is outperformance. It's all about outperformance. We try, or we say we will outperform the Canadian industry by 500 basis points on ROE. Just for information, the investment portfolio, the operating income derived from the investment portfolio, represents 600 to 700 basis points of that ROE, to start with.
We like to say we start the year, day one, with 600 to 700 basis points of ROE in the bag, to start the year. Then we try to get to the mid-teens, which has been our track record over time. The investment team has a big role in playing this. We actually ask the investment team to derive about 160 basis points of ROE outperformance. It's ROE outperformance, and the expectation is they will do that. Half of that will be passive, half of it will be active. This is how we really push our teams to contribute to the ROE outperformance. Over time, they've developed their strategies to support this, whether it's been tougher on fixed income, obviously, but they've been successful overall at achieving the outperformance targets.
We really choose to do it in-house for most of the assets, as long as we have the expertise. If not, we'll go outside because we don't think we can compete with experts if we don't have it in-house.
That's interesting, having the targets. You have your underwriters that are working hard every day to make ROEs on the right-hand side of the balance sheet, and you've got your investing team that are working hard to make ROEs on the left side. Seems like it makes sense to me.
Well, you add the two together, and it's a decent ROE.
Exactly.
So-
That translates back into valuation, then it's what we talk about all the time, is the correlation between the ROE and.
Price to book
Price to book multiples.
Absolutely.
Wins all the way around. Maybe with the counterpoint, we'll go to Ellen with the external management approach.
In the $100 billion general account, there's one asset class where we have an internal capability, and that's in commercial mortgage loans, a place where we've had decades of internal, just strong performance. That portfolio is about 12.5% of the portfolio. The rest of it is all externally managed. The way that this works, and for us, we really feel like this is the best and value differentiator for us on the investment side. Internally, we, of course, set the broad investment strategy. We understand our liabilities. We are investing relative to the expectation of our liabilities. We also know our own risk tolerance and our risk capacity. We broadly set the parameters around the amount of risk that we're willing to take.
My team is also responsible for portfolio construction, we also internally determine the asset classes that we like, those where we believe that there are additional opportunities. We also think about diversification across asset classes, within asset classes, across geographies, sectors, et cetera. We go out and we find the best managers. What we often find is that we talked earlier about multiple opinions, we also find that not every manager is good at everything. We have the ability to pick and choose across various different managers. We have multiple mandates across a number of managers on platform. Additionally, the other place where we really capture value is that we invest in a number of less liquid asset classes, and there where the assets might be more scarce or harder to access, and there's direct origination involved in a number of areas.
If we like it and we want more of it, we're able to go to manager one, manager two, and build out the overall capability for us. The managers, subject to all of our guidelines and parameters, including very tight risk-based limits that we provide to them, are responsible for security selection. They're responsible for security selection. They're the first line of defense, as we talked about earlier, to be monitoring credits as well. They're responsible for their own oversight of diversification and portfolio construction. I have a team that is responsible for holistically looking at the total portfolio, evaluating risk, and risk analysis. Additionally, one of the benefits that we have seen is on the fees side. We've been able to use the power of the balance sheet to really reduce fees.
We can see in statutory filings, for example, that our average investment expense is about 50% relative to the average of our peers. Again, that comes from being able to just negotiate lower fees. Not only do we see value in terms of the investing side, the oversight of the credit risk side and portfolio construction, we get all the intellectual capital. It also costs us less. We think that this is absolutely the right model for Lincoln.
You make a pretty strong case, Louis. You're paying attention, right?
I am, I have to say, again, it's a matter of expertise, and if the expertise is not in-house, we'll go outside. We do use outsiders for some asset classes. We like to say, we talk about outperformance and the expense cost as part of that. We right now are running at three basis points of investment management cost. We're finding that hard to beat.
Gus and Ellen can't beat that three basis points. Three is pretty good, I have to say.
The other aspect I might raise here is what we like about it as well is the scalability. We talked about being acquisitive, and the extra cost for us of managing an extra portfolio is extremely limited. In a context where we know we'll be buying some other companies in the future, we actually like the leverage it provides us in terms of potential savings or synergies from the investment management side as well.
Marty?
Sure.
Maybe a third way, the middle ground. Help us out.
Yes. Well, we're even more internal. About 98%+ of our assets we manage internally. Areas that we do not are, again, areas that we either lack expertise or access. We do have a couple mandates in private placement bonds, both taxable and tax-exempt. Securities that we couldn't otherwise get access to, generally speaking. They source the bonds to us. They're very attractive. On the equity front, obviously, we're big investors in public equity, private equity is a natural add-on. In recent years, we've looked to add a little bit in that regard. We're drawing from a small number of middle market type private equity managers. As far as the active versus passive on the fixed income front, it's a little bit of both. We are fairly passive in the sense that we don't trade frequently.
It's generally buy and hold unless there's a credit event. At the same token, we're not indexers by any stretch. As I mentioned, in the corporate bond portfolio, we're BBB+. We do a great amount of credit work on the front end and then monitor it. On the equity side, again, a very distinct non-indexing strategy. High quality, dividend growth. Do a lot of work on the front end. Tend to own it for a number of years. We do trade the portfolio occasionally, probably about an annual turnover rate, excuse me, of roughly 5%.
Okay.
Our average position is fairly large, so we tend to stick with it. Primarily internal, a little bit of both on the other regards.
Okay. I'm going to take the opportunity at this point to ask whether the audience has any questions. Anything I can go on for hours, but maybe there's something that's on your mind that you'd like to ask about, something to question the panelists on. Anybody? Bueller? Bueller? All right. I got it then. Ellen, you had mentioned the private corporate debt, commercial loans, commercial mortgages. I was in a panel yesterday with some guy, it was a BDC-oriented panel, and the gentleman commented that the market's generally completely misunderstood the CLO market. Maybe you can share some of what you're doing there. You've obviously been very successful. It's been backbone of the strategy. Maybe not the backbone, but an important part of the strategy. Share what you're doing there, how you see the market, where you've been successful, how it all goes.
Okay. I'm going to focus on private debt and commercial mortgage loans. These are two strategies where we have been actively deploying and investing for decades. There's nothing new for us in either of these strategies as an asset class. I'll talk about how we've expanded. In the private debt space, where on average we are purchasing somewhere in the neighborhood of about one and a half billion per year. We traditionally, for decades, had always been in the investment grade syndicated private debt space. This is an area where we also have moved with a number of managers into direct origination investment grade private debt. That's a place where we continue to see good value. We continue to get paid for illiquidity, and we also get really good name diversification. This gets back to portfolio construction and diversification.
The sectors tend to be a little bit different as well. It just really helps to round out the overall portfolio for us. On the commercial mortgage loan side, this is an area also where we are continuing to originate very much up in quality, very aware of what's happening in terms of overall cap rates in real estate. There's still significant value in this space, up in quality in particular. I started really building out this strategy, to increase its size and increase its origination about five years ago. About five years ago, commercial mortgage loans were 7.5% of the portfolio. I mentioned earlier that commercial mortgage loans are now 12.5% of the portfolio. That's considerable growth. We are originating north of $2 billion per year. We are doing this, again, in very high quality space.
To give you a sense, debt service coverage on average, well in excess of two times. Average LTVs are in the mid-50s. For those of you that are familiar with the CML designations in terms of risk Predominantly CM1, which is the highest quality equivalent to a single-A and above, and we're getting paid for it. There also, we think about portfolio construction, broad diversification across sectors and geographies, building a really strong portfolio, and so a great place that fits well into our overall ALM framework as well.
I know in some of these meetings with the bank managers, they sort of grumble about guys like you that are coming in and getting the quality commercial mortgage loans. What would you say to those guys? Are you pricing them better? Are you pricing thinner spreads? I know those guys grumble. I think it's just sour grapes, but I'm an insurance guy, so I would think that.
Well, I haven't heard the gripes directly, but back to my earlier comment, I would say, well, maybe we were here first. I don't know. We've been doing this for decades, and again, track record of strong performance. In our particular space where we play, we predominantly see that we're up against the other life insurance companies. I think some of the places where maybe some of the banks are going is a little bit nicher. That's not where we tend to play. We're not really coming into play with that at all in where we're investing.
I guess if they want something, they're going to have to bring their game because you're already there, man. Marty, let's go to you. You guys have been equity investing for ages. It's obviously a big part of your portfolio. You've touched on a few of the different things, but when you're thinking about a new position or maybe thinking about a position that you have that's not performing the way you like it, talk us through kind of the thought process. What are you guys thinking about? What's the art and science of your investing approach to some of the particular holdings that you have?
Well, you hit on there actually is a lot of You can put any amount of science on it you want, but at the end, there's the art of the decision, right? The judgment on it. As I mentioned, we have roughly 50 plus or minus core positions, three dedicated equity managers divided up by sector. They monitor not only their individual names, but names within that sector, alternative investment ideas, names that generally fit our criteria but aren't quite in our portfolio yet. We tend to, it's not an official list, but we might have a first out, first in kind of a concept within a given sector, whether it's.
Kind of like the brackets that we'll all be filling in about this time next week.
Yes. It'll be busted by Friday, right? Yeah. We meet at least monthly as a group and kind of go over who's on the hot seat, who don't you like these days? There's a significant amount of judgment within that. Anybody can look at the various ratios and data, but at the end of the day, there's a gut feel you have for it, and you make that decision. I ask for conviction on the investment manager's part, our portfolio managers. Dividend, as I've mentioned several times, critical for us, and oftentimes that can be a key initial indicator.
Is it sort of a team approach within your investment managers?
Yeah.
You have three, four, five guys, whatever it is?
Well, there's three portfolio managers. I give them autonomy. They can make their own decisions. It's not that I don't ask them a lot of questions and judge, ask them how they came to this decision and measure that conviction, as I mentioned. It is an individual decision, and they're measured on it at the end of the year, how that performs versus the broader sector, so.
You're the orchestra leader. They play the instruments.
Exactly. Yeah. It's not a real defined process in the sense that we have a black box, an algorithm per se. A lot of judgment does go into it and always has, so.
Okay. Louis, you're the one with the international aspects to the portfolio. You mentioned briefly earlier some currency aspects to that. How do you manage both the currency aspects, maybe some of the cross-border investing, how that maybe impacts some timing of cash flows, things like that? Obviously the mother ship is in Canada. Hopefully the downstream entities are bringing cash at least occasionally. Maybe talk about that whole process, how that kind of all integrates together.
Let's tweak the word from occasionally to regularly.
I hope so. I didn't want to put words in their mouth. They asked me not to.
It's been an interesting journey. We tried to diversify about five years ago into U.S. currency because we knew we had appetite to go abroad, wanted to cover a bit the U.S. or the Canadian dollar exposure, which was 100% at the time. We went into a fixed income portfolio in U.S. dollar and an equity portfolio in U.S. dollar. We hedged at the time the bond portfolio, because we did not want to take currency exposure on the bond portfolio, but we accepted the equity portfolio. We buy OneBeacon, and suddenly we have this new vehicle in the U.S. to own our equity portfolio, and obviously had bond exposure in the U.S. from the acquisition. Just a simple example, the equity portfolio in U.S. dollars from our Canadian business was shifted down into the OneBeacon operation. What does that do for us?
The big advantage, what was previously taxable at 26% in Canada for dividends became partially taxable in the U.S. because we got the exemptions, the dividend exemptions as well. There was immediate tax savings. There was capital advantages of having the equity portfolio in the U.S. operations. This turned out to be advantageous for overall returns. When you manage capital, we suddenly have a U.S. operation, which is, I would say, overweight equities. We have to manage a buffer at the holding company now to make sure that we can absorb volatility like we had in Q4 within our U.S. operation per se. A bit of pressure on the RBC in the U.S. because of capital markets in Q4. We managed that.
We offset it with capital buffers in the Canadian operations or at the holding company, such that we can absorb the volatility and get through. If needed, we would pump more capital into the U.S. operation to absorb it if that was required, and we keep a cash buffer at the holding to be able to do that. It's interesting. The returns are clearly better because we're able to really manage both currencies across geographies better, more efficiently. It does require a bit more management of buffers, I would say, cash buffers, at the holding company to be able to absorb different volatility on each side of the border. Overall, it's been a win-win for us. I would say investment income last year, because of the optimization, was really juiced up for the year, and we see this very positively for the future.
I guess that's one other aspect of all of this. You talked naturally about your general account and your investment portfolio, but I guess that's the third leg of the investment stool is the holding company cash and the liquidity to manage corporate needs, whatever those might be, whether that's a buyback, which everyone loves, or just a regular dividend or a fixed debt interest service, or just the opportunities that you might have in the business, whether that's acquisitions or anything else. It's interesting, the interplay, just because you, of course, have the portfolios that are meant to match your liabilities, but then you have this other almost treasury function that sits over top that has its own little investment dynamic on top of it.
Absolutely. This is a bit new for us, and we obviously manage it carefully. We need to get dividends out to pay dividends and interest payments from the holding. We're extremely careful. We keep a cash buffer and a fairly sizable credit facility. The whole strategy around the credit facility was meant to say, if we were stuck in a crisis situation and couldn't pull out dividends for a year, we could use a credit facility to make our payments. It was a bit of a protective layer that we gave ourselves. Never had to use it, but it's there should we have any liquidity issues. We're fortunate. Obviously, profitability is critical, but we get paid in advance.
Generally speaking, it goes back to the liquidity opportunities, just regular cash flows cover for themselves what we need in terms of outflows, we can really leverage the portfolio with liquidity requirements that are very low and therefore allows us to invest, hold to maturity or invest in less liquid assets. That's been fruitful. It's managing, making sure that we can get dividends up to the holding on a quarterly basis to make our payments, and we've kept a few buffers there to make sure that we're able to meet those requirements.
Anything else from the crowd? Anybody with Okay.
Wondering if you could comment on your allocations to alternative investments within the general accounts, I mean specifically private equity, hedge funds, or maybe structured products and how, where do you see that trending over the next few years?
Lauren?
Sure. Our alternatives portfolio is 1.7% of the overall general account. Within the alternatives portfolio, 83% of the portfolio is private equity. Obviously, 17% is hedge funds. This is an area where we have been The hedge fund portfolio at one point in time was about a third of the overall alts portfolio, we have been trending that down as the performance of hedge funds, it's been okay, as you all know, and our hedge funds relative to benchmarks have performed fine, we see more value in private equity. Within the private equity portfolio itself, we've built a highly diversified portfolio, it's across multiple strategies. We have been shifting into strategies outside of buyout for some period of time.
To give you a sense in terms of the overall portfolio, we have about 1,800 underlying investments in that 1.7%, so that's roughly $1.7 billion alts portfolio. Highly diversified portfolio in there as well. The performance has actually been quite good. When we go and we look back since 2012, the overall average performance is in about the 11% range, which is slightly higher than peers.
Marty, you guys don't really have that many, but if you want to comment, cool. If not, we can pass on to Louis. He has a few.
Yeah. We do very little in the way of alternatives. We have, as I mentioned earlier, started to dabble a little bit further into private equity. It's a little bit of a natural extension. Depending on how it's measured, roughly, say, 6%-7% of the entire equity world is private equity. For us, adding a little bit, we have considerable room to do that. I don't know if we'd ever get to that 6%-7% range. We're being very slow in deploying that capital. More of a middle markets, small to middle market type approach. Hedge funds, we've never done and do not have any intention of going down that path. Probably similar to structured products as well. Unlikely. Private equity would be the vehicle for us.
I would say none on our side.
Yeah.
Yeah.
Okay. Anything? All right. We're running towards the end of the time. I'm going to do something that I learned from CNBC. We're going to do a lightning round here. Real quick, this lightning round. First topic, we're just going to go straight down the line. The next time we'll come back the other way. We'll start with Marty the third time. Interest rates, higher, lower, about the same?
On the short end, about the same. On the long end, higher.
I would agree with that.
Agreed?
I would, too.
That's not fair.
Consensus. Man, I didn't think I could get consensus right off the bat. I thought it would be controversy. I said I was going to pit you against one another and make the bull-bear argument. I learned that on CNBC, too. Everything I learned about investing I got from CNBC. It's kind of sad. Industry sectors. Favorite sector or alternatively, a sector that you hate or avoid? Marty?
In the equity area, consumer staples. It's been a very tough go the last couple of years. A lot of what we considered yield traps in there. Certainly, there's value, but you got to be very careful. I think that's the most challenging sector we look at right now.
I guess our view here is late cycle investing right now, there's a sense of moving away from the cyclicals and being very careful about it. Not necessarily one sector or another. It's more just being in a late cycle environment that what drives our investment choices.
Okay.
Cautious inside of retail, particularly department stores. Cautious inside of energy, particularly offshore drillers.
Okay. The last one, equity markets. Rising, falling, about the same? Louis, you're up first.
I'll say slightly rising.
Slightly rising. All right.
Slightly rising now that the Fed's kind of backed off a little bit, yeah.
Slightly rising.
I think about the same.
About the same. All right, at least we got a little bit of differentiated opinion there at the end. We'll leave it to the audience to pick their brains on all of those particular points. I'd like to thank all the panelists for being with us here today, and hopefully you'll join me in a big round of applause.