Today’s financial landscape is uncertain: initial jobless claims have risen consecutively, the crypto market has crashed, fears of a real estate market ensue, the stock market is in bear territory, bond yields have inverted, and futures markets signal trouble ahead.
While uncertain economic times are nothing new, the rate at which information is disseminated and the interconnectedness of global markets, is. As a result, it is more important than ever for leaders to be thoughtful and deliberate in their decision-making.
According to Nasdaq, diversification is among the best defences against market crashes, including the consideration of alternative investments. Harvard Business School defines them as investments in assets that are not publicly traded on stock exchanges. They are also sometimes called “non-traditional” or “specialty” investments, and include real estate, private equity, hedge funds, insurance-linked securities (“ILS”), and venture capital. Harvard reports that alternative investments are increasing in popularity and are expected to grow 18-24% by 2025. Knowledge about them should therefore be part of every leader’s financial education because many will soon face decisions regarding how to manage them as investors or recipients of capital, Harvard concludes.
While alternative investments can be used to counter the effects of market volatility, it’s important to remember that this category covers a diverse array of assets, many of which are tied to traditional markets and thus still subject to volatility and market crashes. For example, the housing market has recently been described as “in freefall,” with the construction of new houses slowing and demand for mortgages declining. These market fluctuations therefore impact alternative investments in real estate.
Some alternative investments, however, are uncorrelated to the market, offering diversification benefits for investment portfolios. These investments are few and far between, but can be an excellent way to mitigate market volatility driven by the general financial markets, says Stefano Sola. The former CEO and co-founder of Rewire Securities and Merion Square Capital recently joined Vesttoo, a leading risk transfer and investment platform, as their global head of capital markets.
“The current economic, financial and social uncertainty that we are seeing across markets worldwide are driving volatility across sectors, and this is affecting investment portfolios across the board from large institutional ones to small individual ones,” Sola told me. He continued, “Volatile markets can affect anyone. The key to our asset class and our focus on its further development is its potential to remain stable, and placate volatility through limited correlation no matter the current market trend.”
Vesttoo focuses on a particular type of alternative investment: insurance liabilities repackaged into securities, which are consequently transferred to the capital markets. More specifically, the company focuses on less volatile areas of insurance that are not driven by large, unpredictable catastrophe events traditionally associated with ILS. Still, the focus is on non-catastrophe Life Insurance and non-cat Property and Casualty liabilities. This is because the insurance perils in these areas occur at a high frequency and low severity, making them less risky than catastrophe-based insurance investments, which focus on the opposite spectrum of low frequency and high severity risks.
So, why should leaders care? These types of investments are a form of reinsurance, a very established market that has existed since the early 14th century but remains largely undercapitalized. This market offers a variety of new investment opportunities, which have, until now, been very difficult for capital market investors to access due to operational barriers such as a lack of transparency needed to rate and assess these investments properly, concludes Muthu De Silva, assistant dean at Birkbeck, University of London. The OECD agrees, and believes outdated technology is the primary operational barrier, and thus a significant problem. For example, many companies still rely on manual systems, using technology that can’t process the ever-growing volume of data companies now have access to. Indeed, a recent report by Mckinsey & Co. stated that leadership teams need to “develop new business for the digital age.” This includes investing in cutting-edge technology and scaling impact from data and analytics, observes De Silva.
FinTech and, more specifically, InsurTech firms have been attempting to solve this issue using various technologies. “Artificial Intelligence (AI) in particular, can process enormous amounts of data and analyze it to create better financial models, investment analyses, and more accurate predictions,” says De Silva. “If you have a lot of data, but no idea what to do with it, A.I. can be very helpful in extracting value from that data,” she explains.
Vesttoo, for example, uses AI to model non-catastrophe insurance liabilities and package them, creating reliable, diversifying investment products for customers. Their application uses large amounts of historical data from insurance portfolios to structure financial assets that can have stable and predictable returns. “This technology also makes the process more transparent, creating a digital platform where investors can analyze and access insurance-linked investments directly,” observes De Silva.
Vesttoo has, to date, provided more than $2.8 billion in capacity for insurers, demonstrating sizable traction and profits in times when similar firms worldwide are struggling in both areas. As global head of capital markets, Sola told me he would be working to help Vesttoo expand their ventures further, including raising capital for their flagship Insurance-Linked Program and broadening access to their other, more direct, investment products.
“Vesttoo is not only helping to open access to an alternative asset class that will become a mainstay of many portfolios but is also working with investors to become more familiar and comfortable with taking this risk and understanding how it can help manage portfolio volatility and returns through diversification,” said Sola. He continued, “Vesttoo and its product offering are not only timely but are much needed to help mitigate the current state of the market. It’s quite exhilarating to be at the centre of it all.”
Looking inside the alternative investment space evidently provides leaders with valuable lessons in leadership, such as the importance of continuous innovation. Vesttoo and other firms such as Crystal Capital Partners demonstrate how technology adoption and integration can propel a business forward amid financial uncertainty. Crystal, for example, utilizes cloud-based proprietary quantitative analytics, portfolio optimization technology, and qualitative research to help financial advisors build intelligent, institutional-quality private equity, private credit, and hedge fund portfolios. “This is a key lesson for leaders everywhere,” posits De Silva. “The advancement of technology amidst today’s uncertain financial landscape truly emphasizes innovation’s importance.” She continues, “Regardless of whether you work within the financial industry, innovation is a universal language, and thus, presents opportunities for all to garner competitive advantage.”
In summary, the rise of advanced technologies such as AI is transforming the business landscape, particularly within but not limited to financial services, at an unprecedented rate. In such a rapidly-changing environment, it is evidently more important than ever for leaders to stay ahead of the curve. But as De Silva concludes, a fusion of technology and human expertise can truly make a difference in troubling economic times – and that’s an insight from which leaders everywhere may take some comfort in the coming months.