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Institutional Investment - February 23, 2012

There is a clear benefit for those companies who can optimise their capital by implementing an internal model - an interview with Pascal Duval

In this month's interview, we talk to Pascal Duval, Chief Executive Officer, Europe, Middle-East & Africa, with Russell Investments, about EDHEC-Risk's newly-released publication on Solvency Benchmarks, the implementation issues involved with these benchmarks and the challenges facing the insurance sector in Europe.

Pascal Duval

When we spoke last year, you told us about the background to the Russell Investments research chair on Solvency II Benchmarks at EDHEC-Risk Institute. The foundation paper for these benchmarks, “Introducing the EDHEC-Risk Solvency Benchmarks – Maximising the Benefits of Equity Investments for Insurance Companies facing Solvency II Constraints,” has just been released. What are the key take-aways from this publication for Russell?

Pascal Duval: Russell has always believed that investors should be able to benefit in a risk controlled manner from the risk premium of equities, which are one of the strategic asset allocation classes for long-term investors.

It is clear that Solvency II is pushing insurance companies towards an approach that is excessively focused on questions of short-term solvency. It is naturally important to be attentive to the solvency of an insurer but it should not in our view overshadow the fact that the insurer should be able to manage the premia and savings with which it is entrusted in an effective way over the longer term.

That is the primary objective of the research conducted by EDHEC-Risk, which we are supporting. It involves reconciling life-cycle-type approaches that genuinely take the investment time period and horizon into account with the short-term solvency constraints imposed by Solvency II. We think that it is a perfect fit with both the state-of-the-art of research in finance and the concerns of professionals.

The results presented in the study confirm that the proposed dynamic EDHEC Solvency II benchmarks can be designed so as to allow for a more efficient use of the Solvency II risk budget compared to standard static strategies. How do you see these welfare gains being applied in practice?

Pascal Duval: There are three key components we believe to any effective solution: the equity portfolio, the cash portfolio and the dynamic process for allocation. Active management also presents opportunities to add value in excess of the benchmarks. A successful solution addresses all of these components of the EDHEC-RISK Solvency II Benchmarks.

Management of the total portfolio is critical to the integrity of the solution. The insurer may have a desire to pursue active management through high conviction alpha generating managers, but there is low tolerance for active risk (to remain consistent with the EDHEC-Risk Solvency Benchmarks), and a strong desire to avoid negative performance outcomes. Even with a mix of diversified managers, a portfolio can be left exposed to crowded trades, unintended bets and significant deviations from the dynamic allocation benchmarks. Specific stock characteristics of the derivatives utilised should be incorporated into the management of the integrated solution. Strategic and tactical style bets need to be managed at the total portfolio level, and over the market cycle for both risk and alpha considerations. Our solution combines all of this and adds an additional layer of governance, risk management and reporting.

The Solvency II Benchmarks were presented at seminars in London and Paris recently. Can you tell us how they were received by the industry?

Pascal Duval: They were welcomed by the industry and received a lot of interest. Up until now, this kind of equity investing with a floor could only be achieved using structured products. For insurance companies, this is not an optimal solution given the high costs and lack of transparency. Insurance professionals are interested in alternative ways of investing in stocks and these benchmarks provide them with total transparency and replication capacity, thereby avoiding the high costs.

Besides, the integration of the horizon in the dynamic allocation proposed by the benchmarks, constitutes a big step forward compared to the fairly classic CPPI-type approaches offered by investment banks. Ultimately, the Solvency II benchmarks provide an assurance not on an asset but on an optimal dynamic allocation strategy that takes account of evolutions in the state of the world over time and the investment horizon.

The benchmarks allow numerous companies to avail of a transparent investment reference for allocations to equities.

The design and implementation of simplified versions of a partial internal model for the equity risk factor in order to respect the Solvency II constraints is challenging and requires quite an amount of expertise. Why do you think Russell is a good fit for European insurance companies?

Pascal Duval: To make such an integrated solution a success, we can combine our core strengths and internationally recognised areas of expertise:

  • Strategic asset allocation and manager research have been the core of everything we've done since the 1960's. We currently have over $2 trillion in assets under consulting.
  • We have a long track record of putting these investment ideas into practice, managing multi manager funds and multi asset solutions for over 40 years, with over $150 billion in assets under management. This expertise in active management is enhanced by the index business, giving us real insights into the passive side of this challenge. We are therefore perfectly positioned to manage relative risk in relation to the Solvency II benchmarks.
  • Over the years, we have developed the ability to carry out dynamic allocation in the best possible conditions by implementing overlay-type strategies which allow for differentiation between dynamic management of betas and investment in alpha.

How does Russell Investments view the insurance market in Europe and how do you see it evolving?

Pascal Duval: Solvency II is more than just a regulation, we see it as a game changer that will transform the industry in many ways. Product development, investment strategy, hedge strategy and risk management will all be affected. Also, there is a clear benefit for those companies who can optimise their capital by implementing an internal model. This in particular will benefit the larger companies disproportionally. In the area of investments, Russell’s solution developed around the EDHEC Solvency II benchmarks is a way to provide a level playing field for the other companies.

About Pascal Duval

Pascal Duval is executive managing director of Russell Investments for Europe, the Middle East and Africa (EMEA) region, based in London. Since he joined Russell in 1994, Pascal has held various positions in Europe. He has been head of partnerships and distribution alliances business in EMEA, which included responsibility for development of new strategic relationships across the region, such as Russell’s multi-manager fund programmes for the U.K. with the Lloyds TSB/Scottish Widows Group, Italy with ARCA SGR Spa, France with the Société Générale Group and Israel with Bank Hapoalim. Pascal plays a key role in raising Russell’s profile in the marketplace and is a frequent speaker at investment conferences and seminars. Pascal is a member of Russell’s global leadership forum.

Prior, Pascal was managing director and head of Russell’s institutional investors business in the EMEA region.

Before moving to London in 2001, Pascal was based in Russell’s Paris office, as managing director of the French office. Prior to this he was director of Russell’s consulting and analytical services operations in France. He was responsible for developing those lines of business, including the ongoing development of client relationships.

Prior to Russell, Pascal worked for Wyatt Paris from 1989 to 1994 as a consultant in the company’s newly created asset consulting department. He was involved in the development of the business and performed asset allocation work, money manager searches, performance attribution and other major asset-related projects. He spent one year with Eurospet Associés, an organization and information systems consulting firm, where he consulted with financial services companies.

From 1985 to 1988, Pascal worked as a commodity trader on physical and futures markets for Riz et Denrées, an international commodity trading company.