Panel, Conference Presentation
MI Summit 2013 - London: Global Capital Markets: The Forces Shaping the Future of Finance
Milken InstituteLeon D. Black, Tom Finke, Mitchell Julis, Scott Minerd, David Zervos, Michael Milken, Mike Clouton
- Central bank liquidity incentives are driving capital out of cash and risk-free assets into riskier classes, creating an environment where inaction carries high costs and encouraging the search for tangible assets like physical buildings and equity to avoid devaluation from monetary expansion.
- In Japan, approximately 54% of household financial assets remain in cash, presenting a significant challenge in shifting capital to private equity or credit products among an aging, risk-averse population, while the U.S. insurance industry faces $10 trillion in assets with a growing demand for high-quality, long-dated instruments.
- U.S. insurance regulations and risk-based capital rules currently restrict allocations to high-yield bonds at roughly 6% and equities to 2% to 4%, forcing a focus on investment-grade bonds and investment-grade project bonds in Europe which are expected to yield two to four percentage points more than corporate debt.
- Institutional investors are adapting to a low-interest-rate environment by increasing allocations to infrastructure, structured credit, asset securitization, and illiquid credit products including energy mezzanine, healthcare mezzanine, non-performing loans, and stress-performing loans in Europe to achieve competitive returns.
- Specific institutional targets include Guggenheim's long-term rate of return goal of 6.5% through a mix of high yield, securitized assets, securities lending, and infrastructure, and Apollo's expansion of a credit business constituting over half of its $120 billion in assets, with a plan to add another six mandates allowing flexible capital deployment over 15 to 20 years.
- Pension funds are expected to operate on a three- to five-year horizon to benchmark against indices like the Barclays Aggregate, contrasting with the short-term, erratic withdrawal flows typical of mutual funds, while Apollo anticipates utilizing distressed buyouts, corporate carve-outs, and conventional buyouts to maintain discipline over the next year.
- The Fed balance sheet is projected to reach $4 trillion, while the European Central Bank may reinsert Long-Term Refinancing Operations (LTROs) and commit to extending the alternative financing system to address underdeveloped market-based credit compared to the United States.
- European banks are expected to play a diminishing role in financing high-yield credit as institutional vehicles take over liquidity transmission, a trend mirroring the U.S. market trajectory since the 1990s, with Canyon Capital accumulating approximately $2 billion in European loans as banks de-lever amidst central bank-backed deposit guarantees.
- The shadow banking system is forecast to rejuvenate through central bank expansion, offering double-digit returns via restructurings, deleveraging, and leveraging, supported by instruments like the European Investment Bank's project bonds modeled after the U.S. Build America Bond program to stimulate infrastructure and employment.
- Risks identified include a high probability of rising interest rates creating pressure on capital pools to generate long-term returns, the potential for very large and destabilizing financial distortions if the Fed fails to return market forces to pricing, and the possibility of future inflation due to a lack of political will to end quantitative easing.
- Monetary policies are expected to cause political ramifications and social stratification by taxing those without capital and older generations with short time horizons, potentially leading to government shutdowns and social unrest in Europe and the U.S., while the Milken Institute Center for Capital Markets aims to create "non-bank banks" to de-risk financial systems globally.