The Western Asset Approach to Customized Client Solutions

Western Asset has been investing in fixed-income markets for the benefit of our clients for nearly 50 years. In that time, we’ve been through several market cycles and have worked closely with a variety of clients across many industries to develop a customized approach that leverages the maturity of our analytical platform and the wide range of analytics capabilities and experience across the Firm.

In 2018, we formalized our Client Solutions Team, which is committed to addressing and analyzing our clients’ investment-related challenges, and to help them with their quantitative analysis and risk management needs. The deep experience of the team is instrumental in providing insightful analysis that includes consideration of a broad historical context along with awareness of current and potential risks.

An essential tool utilized by our Client Solutions Team is Western Asset’s proprietary and industry-leading risk management platform: WISER, the Western Information System for Estimating Risk.

WISER: A Smarter Approach to Managing Risk for Clients

Western Asset realizes the importance of offering the highest possible level of risk management and analytics resources for our clients. After a multi-year development process, WISER was introduced to clients in 2015. WISER’s primary purpose is to estimate and help create better risk/reward profiles in client portfolios. It provides a comprehensive and powerful analysis and reporting platform.

One of the most common services our clients request is a quantification of the risk profile in their investment portfolios and for us to define the drivers of risk. To address this need, our Client Solutions Team deploys WISER, which facilitates the analysis of portfolio risks that originate from different areas of the capital markets. WISER has been instrumental in supporting our portfolio managers with both portfolio construction and ongoing risk monitoring.

Accordingly, when defining risks, the Client Solutions Team focuses on measuring the overall risk profile and its drivers, assessing risk attribution and providing clients with greater insights about the sources of potential portfolio volatility and tail-risks.

Working With the Client Solutions Team

The Client Solutions Team is a group of highly trained professionals with vast experience in the financial industry. The team partners with clients to help them address complex portfolio and risk management issues. They provide tailored quantitative analysis and risk management support, and help Western Asset’s clients in developing bespoke investment portfolio allocation and/or risk solutions specific to their needs, leveraging Western Asset’s analytical, quantitative and other resources to provide customized solutions to support its clients.

The team typically begins a client engagement by downloading a client’s individual portfolio holdings and assigning relevant analytics to securities as well as making other relevant assumptions. The team puts an emphasis on defining the drivers of risk to help clients understand the origin of the risks facing their portfolios. The goal is not simply to generate risk reports, but rather to compile the resources to best help a client understand their unique risk profile to better inform a dialogue around risk that we can turn into an ongoing discussion about their investment portfolio.

It is worth noting that while some clients are interested in this type of analysis as a snapshot of their current portfolio, others have an interest in more deeply understanding their risks on an ongoing basis. Western Asset is committed to addressing both types of client requests. Our goal is to create and support a continuous and comprehensive extension of our clients’ risk management programs.

Common Investment Issues Facing Our Clients

We categorize our client solutions approach into six broad categories:

1. Crafting capital efficient portfolios
2. Assessing an investment portfolio’s risk profile
3. Stress testing and scenario analysis
4. Asset allocation modeling
5. Cashflow modeling
6. Asset/liability-focused portfolio management

To provide a recent example of the Client Solutions Team’s work, let’s examine a common issue facing our insurance clients: crafting capital efficient portfolios.

Crafting Capital Efficient Portfolios

The Issue
Many of our clients in the financial sector, such as insurance companies and banks, are subject to a number of detailed rules and guidelines for their investment portfolios that have direct impact on their capital. Thus, insurers and banks around the globe have to operate under different regulatory environments, and the traditional risk/return trade-off becomes more complex under capital efficiency rules, which differ across jurisdictions. Certain financial institutions operate under a number of rules and regulations that have direct capital position impacts as well. Western Asset manages portfolios across several jurisdictions, including different states in the US. Consequently, the Firm has deep regulatory expertise and associated capital models for different regimes. In many cases a single client may operate across multiple jurisdictions. Within the US, there are relatively small differences between state regulations, given the efforts by the National Association of Insurance Commissioners (NAIC) to harmonize different regulations. Regardless, Western Asset can manage these differences, which typically do not impact our management of portfolios, but may impose additional reporting requirements.

In our view, the primary impact of different regulatory regimes is the methodology for calculating capital charges. For instance, there could be two portfolios with the same objective of capital-efficient yield, with one under NAIC and the other under Solvency II, which will likely end up with different sector allocations. The NAIC portfolio will typically have a relatively large allocation to structured finance because it has favorable treatment under these rules. The Solvency II portfolio, by contrast, will typically have no structured finance due to punitive associated capital charges. Under the NAIC framework, the credit risk charge of a bond depends upon its credit rating (the “NAIC rating”) but not its maturity or duration.

Securitizations receive further capital relief under a price breakpoint calculation. Under the Solvency II framework, by contrast, the spread risk charge of a bond depends on its credit rating and duration. Thus, all else being equal, longer-duration bonds have higher capital charges than shorter-duration bonds. Specific types of bonds receive carve outs for favorable treatment. For example, sovereign bonds issued by EU member states receive a 0% spread risk charge regardless of credit rating; thus Italian, Greek and Spanish government bonds receive the same 0% spread risk charge that German and French bonds enjoy. Additionally, bonds of certain supranational agencies also receive a 0% spread risk charge. The section of the regulation granting preferential treatment to certain types of bonds (Article 180–Specific Exposures) is partially harmonized to the Basel III banking regulation. As noted earlier, securitizations are treated unfavorably under Solvency II, but the regulation may evolve over time as proposals such as the Simple, Transparent and Standardized (STS) framework are considered. For now, Type 1 securitizations—defined as those that satisfy a number of quality criteria—are treated less punitively than other (i.e., Type 2) securitizations.

Infrastructure debt is another example of a sector that receives favorable treatment (typically a 25%-30% reduction in spread risk charge) under Solvency II. In addition to charges for spread risk, the Solvency II framework also encompasses charges for interest rate, currency, equity, default, and concentration risks. Aggregation across risk factors is based on a specified correlation matrix, typically resulting in some correlation benefit. The Solvency II standard formula is based upon shocks relative to a 99.5% confidence level and a one-year time horizon.

The Solution
All these considerations play a role when seeking to optimize a portfolio for capital efficiency and yield objectives under a variety of constraints. In response to these parameters, Western Asset built a Solvency II standard formula calculator that is integrated into the Firm’s other systems and processes, including compliance limit monitoring. Western Asset also has experience with application of Solvency II equivalent frameworks globally. These equivalents typically differ from Solvency II in calculation details, as well as in the granting of preferential treatment to bonds issued by their own governments and institutions. Australian LAGIC, for example, grants preferential treatment to bonds issued by the Commonwealth, to states and territories, and to covered bonds issued by authorized deposit-taking institutions (ADIs) as defined by their regulator, the Australian Prudential Regulation Authority.

In Summary

Western Asset has a strong and comprehensive suite of analytical and quantitative tools, a well-established risk platform, and nearly 50 years of experience in virtually all global fixed-income markets. Over the years, our analytical capabilities have grown dramatically to address needs of financial institutions all over the world. These include numerous high-profile pensions, insurance companies, sovereign wealth funds, central banks, trusts and endowments, advisors, and many others located in North America, Europe, the Middle East, Asia, Australia and Latin America.

We understand and truly appreciate that each client is unique, and each investment solution requires deep analysis and commitment. Western Asset’s Client Solutions Team is committed to bringing our best resources to partner with and support our clients to help them understand the risks facing their portfolios and craft the best possible investment solutions for their unique situations.