Why Lloyd's is well-placed to tackle next downturn

Chairman Lord Levene in effect said as much when he warned that insurance rates were falling, and the focus more than ever had to be on underwriting for profit. This is the key issue. The insurance cycle is one of boom and bust. When profits are high, new entrants with new capital rush into the industry.

The additional competition drives down rates for everyone, and the industry as a whole is faced with an uncomfortable choice of take it or leave it. Does the underwriter do the business at rates that make a loss highly likely, or does he turn it away in the knowledge that he may well not be able to deploy the capital he has at his disposal, thereby also guaranteeing a loss.

In the past, the industry has started off resolutely high minded and sensible, then cracked and got into a savage loss-inducing dogfight over scraps of business. One hesitates to say that this time it will be different, but at least Lloyd's has mechanisms in place designed to stop its firms joining in the suicidal charge.

Rolf Tolle - Lloyd's franchise director, or custodian of its good name and reputation for sound business practice - has far greater power than ever before to examine and challenge business plans and throw out the more insane. He recently agreed to extend his contract, which suggests he is looking forward to the fight. Lloyd's has been fortunate that he has recognised this is absolutely not the time to leave, or hand on the task to someone less experienced. Even so, he will have his work cut out.

But there is another discipline. There is little doubt the market is turning down - that was certainly the mood music from an industry gathering in Monte Carlo earlier this month - but that makes this the first slowdown at Lloyd's when most of the businesses are individually listed stock-market companies.

The likes of Hiscox, Amlin, Catlin and Beasleywere not listed in the last big slowdown. The big question is whether stock-market discipline, or outside investor discipline, will succeed where the insurance industry itself, left to its own devices, has failed. Will these companies return surplus capital to shareholders rather than burn it up in a deadly chase for market share?

Time will tell, although there have been some encouraging signs. But there is as yet no sign of the other logical strategy to cope with the coming poor market. One industry leader is vociferous in his view that the best strategy now is for companies to merge. They would then cut out the weaker lines of business on both sides, leaving them a 100% high-quality book. This would not only see them through the downturn but would also leave them admirably positioned for when things start to get better again. It seems to make sense, but as yet no one has bitten. Perhaps rates need to fall a bit further first to concentrate the minds.

Emerging markets are roaring away. They were booming anyway but since the summer credit crunch and the growing belief that the US and UK economies are going to slow down, caution has been thrown to the winds. The money is pouring in, the shares are roaring up.

It is easy to see why. We are assailed on all sides by the growth story of Asia, and with the evidently fast-growing power of the BRIC countries, Brazil, Russia, India and China. It is hard to argue that these are not the places to invest.

However, many of these markets have risen so far so fast that some describe it as a bubble - a market where prices have lost touch with reality and are rising simply because they are rising. Others, however, including Capital Economics' Roger Bootle, reckon there are solid reasons for the valuations, and the word bubble is inappropriate.

But in reality the bubble is not the issue. The question should be whether it is wise to invest in emerging markets at all. Three London Business School professors have over many years compiled an unrivalled database of share-price movements of all markets, going backmore than 100 years in the UK and to inception for most emerging markets.

Every year, they produce an analysis of long-term investment returns, published as a book by ABN Amro. A couple of years ago, they devoted a chapter to an analysis of the long-term performance of emerging markets. They discovered something that demolished the case for emerging-market investment - the faster economic growth of these countries did not translate into outperformance of their stock markets. In the medium term, a portfolio of German or US shares always did better than a clutch of emerging-market investments.

This is totally counter-intuitive, so they suggested reasons why this might be so. One was that many of the key drivers of economic growth in emerging markets do not get listed on the stock exchange, whether because they are government-built infrastructure or, particularly in Asia where family businesses are the norm, because they like to keep the jewels to themselves.

By the same token, companies that are listed can suffer from alarming deficiencies of corporate governance, so the outside investors never quite collect the due return.

It is also the case that while every year it is an emerging market that tops the world's charts, it is almost never the same one twice. It is the global parallel of the debate between growth and value investments. Short-term, the growth is seductive, but it is the value investor who outperforms.