RE: Global Funds - Expected Returns - Risk Rewards6 Apr 2020 18:50
2. What is the Risk Reward Profile?
Although the market is considered low risk an investor can unwittingly make high risk decisions, at a policy level, that can impact their returns. For example, an investor may purchase a tertiary portfolio for far less than the original purchase price with the expectation of above average returns. However, this portfolio may exhibit poor mortality experience. This may be due to poorly executed buying decisions and due diligence or flawed life expectancy estimates when it was originally constructed. (If something is cheap there may well be a good reason for that).
As the popularity of the asset grows some investors are demanding a quick return profile with a high level of liquidity. This is typical with the marketing of retail investment schemes. However, this asset requires a patient investor with the ability and will to hold to maturity. Investors should commit to at least 8 to 10-year horizon in order to realise respectable gross risk adjusted return.
As mentioned earlier, insurance based instruments perform to in a manner totally unrelated to traditional investments.
The returns both predicted and realised, are driven by the probability and then the eventual timing of the insured risk occurring. In the case of secondary life insurance contracts, the returns will normally occur along a predicted mortality curve based on a set of data of historical experience. This data is accumulated and refreshed regularly by underwriters and is derived from data from thousands of similar cases. Contained within this resulting data will be a point that the industry calls “life expectancy” but in reality, is only the median point (the 50th Percentile). However, what the graph clearly shows is a period of time (which may be several years) where the event is statistically “most likely”. This is still not a guarantee.
Here below is a sample curve from one case. Obviously, a portfolio will be made up of many cases (the more the better) and the average shape of the portfolio’s curve will be driven by many factors. These include (to name a few) the variability of case size, the variability in insured characteristics, the variability of median predicted tenor. The actual insured event will occur randomly along the line in a manner idiosyncratic to that case.
A portfolio is constructed, valued and returns are forecast using the predicted mortality data. In a portfolio, the narrower the band of projected returns, the more certainty there is that those events will occur in that time frame. Conversely, a portfolio with a wide predicted mortality spread would be expected to have more volatility of returns. To mitigate against volatility in returns, the investor needs to be aware that as the size of a portfolio (the number of cases) increases so does the confidence in the statistical predictions.
https://globalfundsearch.com/blog/investing-in-life-settlements/
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