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Steering a new allocation path for insurers in dynamic markets
In a world where all assets do not go up in lock step, insurance investors should prioritise flexibility, dynamism, and forward thinking, says Tim Antonelli, head of insurance multi-asset strategy for Wellington Management.
Ready for a new world order
The wild ride investors experienced in equities in early August was the latest reminder of how unpredictable today’s environment is. At the same time, and especially for long-term investors such as insurance companies, the volatility that briefly shook markets also sharpened the focus on just how important it is for portfolios to be prepared. Resilience, diversity, and agility are essential ingredients for asset allocation strategies today.
Investors have grown used to rapid shifts in macro and market narratives. Divergence in monetary policy has increased as central banks around the world try to find the right balance between growing their economies while moderating inflation. There is also an “isolationist” tone to fiscal policy, as governments focus on on-shoring or near-shoring systemically important industries and sectors amid a broader overall deglobalisation trend. Further, 2024 will see over 60 elections worldwide.
Not every event will be as far-reaching as the US election or US Federal Reserve (Fed) decisions on interest rates. But collectively, they accentuate the “noise” at the margins, plus test historical relationships across asset classes.
Despite this backdrop, the global economy remains on relatively strong footing. In the US, for example, recent earnings have surprised on the upside and consumers continue to spend. A softening in the labour market has, in turn, lined up the Fed to potentially start cutting rates in the latter stages of 2024 and into 2025, perhaps aggressively.
In general, this situation is encouraging for insurance investors from a fundamental perspective. Yet there are left-tail risks to consider. In particular, significant geopolitical risks and the associated market volatility have, arguably, never been higher.
Three ways to prepare insurance portfolios
It is no surprise that many insurers were not ready for the swings we have seen over the past 12 to 24 months. In response to the current regime, however, these investors should consider a three-step approach:
- Look past near-term market noise to invest in long-term winners: When the market sells off, take the long view and buy the correction. While it may seem painful at the time, over the long run this is a strategy that works to build surplus.
- Plan for a “normalised” rates environment: Given that the lofty all-in investment yields are likely to disappear in the not-too-distant future, it is essential to have a game plan for yields in a “normal” rate environment. In line with this, allocations should consider investment grade private credit, as well as diversification into securitised assets.
- Consider the exposure to the US trade picture: A Democratic presidency likely has a better near-term outlook for developed markets outside the US, while a Republican presidency may have a US bias. Paying close attention to regional bets will become increasingly important, especially if deglobalisation continues to play out, given the subsequent wide-ranging impact on many multinationals.
Adapting allocations to a dynamic world
As insurers globally grapple with this new regime, their portfolios should reflect expectations of sustained inflation and macroeconomic volatility.
Put simply, the potential for the greater frequency of periods marked by stagflation, or high inflation/high growth, calls for more creativity. Traditional inflation-hedging assets like commodities or precious metals face hurdles such as significant capital charges and P&L volatility, plus can fall foul of sustainability goals.
Instead, insurers can consider options such as dedicated inflation-linked bond mandates, emerging market debt, REITs, and real estate broadly, infrastructure with inflation pass-through deals, and more floating rate exposures across fixed income sectors.
For insurers’ illiquid asset exposure, the need for diversification within this part of the portfolio is ever-more acute. A sensible strategy would be to invest up and down the credit quality spectrum, and to diversify by both manager and year of vintage. In addition, secondary markets can be effective sources of risk management while also building out target allocation levels and selling assets as a way to manage concentration risk.
Meanwhile, insurance investors should also ensure they have off-balance sheet funding sources available – such as via lending agreements or letters of credit – to use as options, if needed, in the event of a major idiosyncratic liquidity need.
A nimble and tactical mindset
Ultimately, insurance investors must become more opportunistic to take advantage of the greater levels of dispersion which look set to define the macro and market environment for the foreseeable future.
In short, this requires “solutions.” For example, many insurers have specific return objectives for their surplus investments but also have risk tolerance limits impacted by drawdown amounts or risk capital consumption. There is no “silver bullet” – the best approach is a variety of building blocks to achieve the overarching investment objective while staying within risk parameter targets.
The traditional investment governance structure where strategic asset allocation (SAA) is reviewed annually – and potentially tweaked – is no longer dynamic enough to tackle market dislocations or capitalise on windows of opportunity from a macro shock.
As a result, to keep portfolios relevant and achieve investment goals, insurance investors need to create a framework designed for dynamism. Achieving this involves streamlining the implementation process and looking across asset types and within asset classes. We believe that starts by working with an asset manager to reassess the SAA as a necessary first step to any portfolio changes.
There is a pressing need for this given the current unprecedented challenges, which call for unconventional and, often, customised solutions. Our approach is tried-and-tested – it is a collaborative, strategic and proactive investment and risk management process which gives insurance investors diverse and unique perspectives to help them be well-prepared.
We have been building investment partnerships in this way with insurers since 1975. Today, we act as a fiduciary for over 165 of them worldwide, representing $160 billion in general account assets as of 30 June 2024.
To read more insights from Tim Antonelli, click here.
Disclaimer:The views expressed are those of the authors at the time of writing. Other teams may hold different views and make different investment decisions. The value of your investment may become worth more or less than at the time of original investment. While any third-party data used is considered reliable, its accuracy is not guaranteed. For professional, institutional, or accredited investors only.
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