What does 2024 hold for the asset classes favoured by insurers? Will there be winners and losers: if so, where? Our team of experts looks at what 2024 might hold.
Following last week's look at some of the “big picture” issues that will create the context for portfolio management this year, our experts take a deep dive into the implications for specific asset classes and investment strategies. In doing so, they highlight some of the serious – and overlapping – challenges around infrastructure assets and ESG strategies. Just as the impacts of climate change grow in scale and frequency, will the greater rigour being applied to validating ESG strategies dampen enthusiasm for claiming to have embraced ESG?
Pramila Agrawal (PA) director of Custom Income Strategies, Loomis, Sayles & Company
Simon Richards (SR) Head of Insurance Solutions at Insight Investment
Andrew Torrance (AT) Chair, Insurance Non-Executive Directors Forum and Tokio Marine Kiln Syndicates. Former chief executive of Allianz Insurance plc
Erik Vynckier (EV) Board Member, Foresters Friendly Society & Chair of the Institute and Faculty of Actuaries (Research & Thought Leadership Board)
David Worsfold (DW) freelance financial journalist and contributing editor to Insurance Investment Exchange
- Which asset classes will be the winners in insurer portfolios in 2024?
PA: We see three unique drivers of return or risk factors: corporate credit, real estate and related assets, and asset-based lending, all of which span the public and private markets, the capital structure and the quality spectrum.
We are neutral on corporate exposure given the future direction of interest rates as some of these firms, particularly weaker ones, need to come back to the market.
On the commercial real estate side, we are more negative in a high interest rate environment that has completely changed the cost of funding and will continue to create stress. When we look at insurers’ balance sheets, we have seen heavy exposure to the office sector.
In the asset-based area, we are seeing that that industry has long been dominated by the banks. Given the retrenchment of bank lending, we expect attractive opportunities in the US securitized markets. We are also seeing the emergence of various lending platforms, both on the public and private side providing a global investment opportunity over the coming 12 to 24 months.
For those with an opportunistic bent to their allocation process, there will be pockets of good investment ideas in corporates and real-estate lending.
Investment grade EM has been fairly resilient, offering diversification and added carry so we can call that one of the winners.
SR: Insurers are likely to be adding more investment grade fixed income, including municipal debt, and we have seen a trend towards investments that have an ESG focus. This will be particular the case in some areas of Europe, where insurers are likely to use the higher yields now available on IG assets to close the existing duration gap between assets and liabilities.
Assuming we get official interest rates moving lower and that recession is avoidable, equity and high yield will likely be good performers, but expect some volatility. For this reason, strategies that can be more dynamic between asset classes may be appropriate.
AT: Several investment houses were bullish about 10 year government bonds for 2024 during the final quarter of 2023. However, there was a dramatic fall in their yields in the final two months of last year which probably means a lot of the upside has already gone. I expect relatively short term investment grade corporate credit to perform well in the coming year.
- If there are winners, there will be losers. Which asset classes could fall out of favour and why?
SR: From a cyclical standpoint the US$ is likely to struggle. Illiquid assets also face headwinds as the troubles in the wake of the gilt crisis highlighted their unsuitability for a range of portfolios. It is likely that some insurers may review their allocations to illiquid assets to determine whether the additional illiquidity and complexity is sufficiently rewarded given the higher yields now available on core assets.
AT: The commercial office property sector in the west could face a challenging year as demand continues to be pressured by changes in working practices and by property owners facing refinancing maturing debt at much higher interest rates.
EV: The drift in infrastructure from cash flow generative investments in daily operation, with a reasonable visibility for decades of service, to projects depending on rerating and upped exit valuations (private equity style): such as wind farm project firms pursuing the “originate-to-distribute” model once completed has to be a concern. There has been a fundamental change in the economics and risk of infrastructure which investors have unfortunately not understood. It is a different beast today from 10 years ago; risks are very different and the investment is far less attractive.
DW: There must be concerns around any assets that catch the eye of regulators looking at liquidity risk. Longer term bonds might not perform so well if this becomes a major factor and infrastructure assets are goig to have to work a lot harder to generate serious interest.
- ESG and climate change: how should insurers’ investment portfolios respond to the varying ESG agenda(s)?
SR: Insurers have obligations from regulators, shareholders and consumers about how they incorporate ESG considerations into their businesses. These stakeholders have different requirements. For those insurers seeking to mitigate the environmental impact of their investments, before making any significant changes to the investment strategy, they should ensure they can obtain a high degree of transparency regarding the investments they hold, and fully understand the different trade-offs required for example between engagement and exclusion and between near-term objectives such as a reduction in the carbon footprint and longer-term objectives, such as Paris alignment. Even for insurers without these priorities, this kind of information can still be useful.
AT: Insurers should be positioning their portfolios to support the transition to net zero. What this means for individual companies will differ enormously depending on the sector of the industry in which they operate and in particular, the duration of their liabilities. The industry must avoid any suspicion of greenwashing.
EV: ESG ambitions replace at very high cost existing appliances and applications: cars by expensive and heavy electric vehicles but they are still just transportation, effective power by expensive and unreliable intermittent power from renewables but still just power. There is no intrinsic innovation. It simply fills the same application without any novel consumer benefit or enhancement. The invisible benefit is imputed to be in the process. Costs and complexity are invariably higher.
Compare this to real innovation: fixed line telephones by mobiles, typewriters by electronic text processing, electronic vacuum tubes by liquid crystal displays, open surgery by keyhole surgery. Each of these offers a demonstrable consumer benefit, a better consumer experience, new or enhanced features – they are not about hidden or unmeasurable process intangibles such as being less carbon intense or more biodiverse.
DW: This will be the year where forensic honesty around ESG strategies will come to the fore. Warnings about Greenwashing are already flowing from regulators. Investors must be certain that an asset is everything that it claims to be if they are going to embrace it as part of an ESG strategy. Expect a focus on Greenwishing to be added to this scrutiny, where managers and owners of assets are guilty of convincing themselves of the green credentials of an asset without looking hard enough to see if they can be delivered.
This will lead to a wave of Greenhushing where the strident corporate noises about ESG recede into the background for fear of being accused of claiming virtue where none exists.
Complied by Contributing Editor David Worsfold