MI Summit 2013 - London: Global Capital Markets: The Forces Shaping the Future of Finance

Central Bank Impact on Asset Pricing

• Central banks have made risk-free assets (cash, T-bills) "rich" and expensive to hold, incentivizing investors to move capital into riskier asset classes.
• This strategy, described as the "Bernanke put" or "Draghi put," aims to prevent deflationary spirals by forcing capital into productive risk-taking rather than hoarding.
• Investors are advised to avoid assets vulnerable to currency devaluation by the "printing press," such as cash deposits, while favoring real assets like buildings and equity capital.
• The current environment is described as the "greatest time in history to innovate" due to the high opportunity cost of holding cash.

Regional Market Dynamics: Japan

• Japan serves as a cautionary case where households hoard cash (approximately 54% of financial assets) due to 20 years of low growth and a fear of losing capital.
• Japanese real estate prices remain 65-70% below highs, and the stock market trades more than 60% below its peak, reinforcing risk aversion.
• The challenge for asset managers is convincing Japanese households that transferring capital to institutional managers (e.g., Apollo, Canyon) offers better long-term safety and returns than holding cash.

Insurance Industry Constraints and Opportunities

• The U.S. insurance market manages approximately $10 trillion in assets, with a surge in demand for long-dated fixed annuities driven by aging demographics.
• Insurers face "risk-based capital" rules that limit exposure to high-yield bonds (typically ~6%) and equities (2-4%), forcing a heavy reliance on investment-grade bonds.
• To achieve target long-term rates of return (typically advertised at 6.5% vs. <4% for high-grade debt), insurers are increasing allocations to structured credit, infrastructure, and securitized assets.

Structural Shifts: Banking vs. Shadow Banking

• Non-bank financial institutions (Apollo, Guggenheim, Canyon) are replacing traditional banks as primary lenders, now holding a minority share of bank loans but dominating the alternative financing system.
• The "shadow banking" system has been rejuvenated by central bank liquidity, allowing for the extension of debt maturities and refinancing of the "wall of maturities" that threatened the economy post-2008.
• In Europe, where banking systems are oversized relative to GDP, central banks (e.g., ECB under Draghi) are actively working to expand the market-based credit system to match the U.S. model.

CLO Market and Financial Innovation

• Collateralized Loan Obligations (CLOs) successfully institutionalized the leveraged loan market, utilizing covenant protections to withstand economic downturns.
• Contrastingly, the pre-2008 mortgage-backed security (MBS) market failed due to flawed structure and reliance on flawed regression analysis rather than credit culture.
• CLOs generate "endogenous liquidity" through cash flows from interest and amortization, unlike the market liquidity required for public securities.

Apollo Investment Strategy Evolution

• Apollo manages ~$120 billion in assets, split between private equity ($40B), illiquid credit ($68B), and real estate.
• The firm adopts a "distressed buyout" approach during downturns, focusing on deleveraging over-levered companies with strong fundamentals (e.g., LyondellBasell, where debt was reduced from $25B to $5B).
• Apollo has developed "strategic relationships" with large institutional investors (e.g., Texas Teachers), offering flexible, multi-product mandates with cross-collateralization to provide downside protection and aligned incentives.
• The firm focuses on "credit-oriented private equity," investing up and down the capital structure to identify the optimal risk-reward entry point.

Government Subsidies and Infrastructure

• The U.S. Build America Bonds program (2009) successfully expanded the taxable municipal market by offering a 35% interest subsidy, though it was limited by a short two-year lifespan.
• European initiatives are attempting to replicate this model through "project bonds" supported by the European Investment Bank to stimulate infrastructure spending.
• Investors noted that these subsidized securities historically offered a 2-4% yield premium over corporate debt with minimal principal risk.

Forward-Looking Risks and Political Economy

• David reported concern regarding the political will of central bankers to withdraw from quantitative easing, fearing a return to the inflationary errors of the 1970s.
• Quantitative Easing (QE) creates asymmetric wealth effects, benefiting those with existing capital to take risk while penalizing the savings of the elderly and lower-income populations.
• Scott warned that continued central bank intervention distorts market pricing and urges a return to market forces to avoid destabilizing economic distortions.
• There is a growing trend toward "integrated platforms" where asset managers offer diverse illiquid credit products (e.g., aircraft leasing, distressed loans, non-performing loans) to meet investor yield demands.

Event Logistics

• The panel concluded with an invitation for attendees to a reception on the 31st floor.
• The Milken Institute announced its upcoming 4th London Summit and the Global Conference in Los Angeles for the following April.