Is there any reliable concept of normality for institutional investors as another turbulent year draws to a close? Perhaps the best we can say is that volatility has become the new normal, writes Contributing Editor David Worsfold.
The decade after the global financial crisis saw the investment world adjust to an era of low, sometimes negative, interest rates. This challenged the heavy reliance of insurance company investment portfolios on the traditional mix of fixed income assets. The ‘search for yield’ was a frequently recited mantra, especially by asset managers offering an increasingly exotic range of alternative assets to chief investment officers facing demands from boardrooms for better returns.
Although there was some take-up of the very mixed bag of alternative assets on offer – from student accommodation to frontier markets – in truth this made only a marginal impact on the average insurer portfolio. Fixed income remained core.
The challenge now is that once predictable, steady fixed income assets are being buffeted by a whirlwind of uncertainty.
At the eye of this storm is nervousness about interest rate policy: this shows no signs of abating. Central banks are sending mixed signals about the scope for interest rate cuts and the likely pace of future reductions.
Some of the current hesitation and uncertainty is clearly down to the change of administration in the United States. There are almost as many opinions as there are economic commentators about the likely thrust of President Trump’s economic policies. There is already some obvious tension between the President and the Federal Reserve and how this plays out will impact fixed income and equity markets. Volatility will be the norm
A global recession?
Perhaps the biggest dark cloud on the horizon is the risk of global recession.
The German economic engine that has driven Europe forward for decades has already spluttered into reverse and with elections not due until February it is hard to see it being restarted soon.
Alongside that, the political instability in France has dramatically weakened the Franco-German powerhouse at the heart of the European Union. France is in danger of going through as many Prime Ministers in a short space of time as the United Kingdom. Again, where there was once stability, there is now volatility.
The aggressive noises from President Trump about tariffs and protecting and promoting American trade may turn out to be just that – noises. That is the view of the optimists. A more realistic scenario is likely to be that he will impose some new traffic but they will not be as extensive or as draconian as some fear. The key will be the response of those countries hit by any new tariffs. The potential consequences of a full-frontal trade war have been widely aired and are potentially so damaging that few expect it to come to that. However, it would be a rash investment manager who was not keeping a close eye on the equities in their portfolio, ready to move quickly if certain sectors are impacted badly. Volatility will continue to stalk the equity markets.
Trump’s determination to ensure the US Dollar remains the world’s principal reserve currency will also be flickering brightly on CIO’s radar screens. They will know all too well how a strong Dollar can exacerbate vulnerabilities in emerging markets by increasing the cost and risk of US Dollar-denominated debt, leading to economic instability, inflationary pressures, interest rate increases and potential debt crises.
ESG: facing both ways?
One of the biggest challenges – especially for multi-national insurers with a substantial presence on both side of the Atlantic – will be coping with the sharp divergence over ESG (environmental, social and governance) policies. European regulators’ enthusiasm for pressing ahead with greater integration of ESG policies into insurers’ underwriting and investment strategies – backed with new requirements for enhanced reporting and deeper compliance – are in sharp contrast to the likely stance of the new US administration.
A key element of President Trump’s promise of lighter regulation is a sustained hostility to anything that looks like ESG.
This is widely shared by his Republican supporters. Last year 23 Republican attorney generals combined to shut down the Net Zero Insurance Alliance. We can expect the new US administration to be much more supportive of the fossil fuel sector and markedly less enthusiastic about renewable energy.
It will take a judicious asset selection – and labelling – policy to avoid getting caught in the crossfire between the ambitious net zero targets of the Europeans and the increasing rejection of the concept by the Americans. Climate change will certainly inject further volatility.
That all pervasive volatility has been the hallmark of 2024. It will be the new normal carried into 2025, especially with what seems an inevitable new wave of geopolitical instability to factor in.