In a lively panel discussion on the topic of market uncertainty and the impact of macroeconomic trends for Chief Investment Officers, senior industry leaders said that inflation was increasingly detrimental, fixed income will always be a mainstay, and there are ways to capitalise on the US Federal Reserve's tightening policy.
The debate took place at the inaugural Insurance Investor Live | Midwest 2023 event in Chicago. It included Robert Cataldo, Chief Investment Officer, United Fire Group, Aaron Diefenthaler, Chief Investment Officer, RLI Corporation, and Michael Lohmeier, Chief Investment Officer, IMPACT Community Capital, alongside moderator Stephanie Thomes, Senior Investment Consultant, Insurance Practice, Mercer.
The panel’s central questions were ‘What can Chief Investment Officers expect for the remainder of 2023?’ and ‘How are they navigating the current market environment?’ To the former, all three panellists noted that their biggest concern was a prolonged period of inflation, with a potential recession “perpetually six-to-nine months away”.
“A slow-down is still in the cards,” said Diefenthaler, with Lohmeier adding that his team’s main concern was “preparing portfolios for the impending recession.”
Diefenthaler told Insurance Investor in April that he was excited by the opportunities for durability that Investment-Grade (IG) fixed income provided, especially for Property & Casualty (P&C) insurers looking to support operating earnings. However, he encouraged retrospection and caution, saying that, “we will have to await 1/1/24 [renewals] to truly know what the best opportunity of 2023 was.”
Because of the looming potential for an extreme decline in economic activity, the main theme Diefenthaler saw in the coming months was durability — with a shift back to public equities without discounting private credit. “There has been tightening monetary policy since over a year ago, and we want to take a defensive stance on the yield curve,” he said. “We don’t want to get caught having to reinvest only in the short-end of the curve.”
“We want to take a defensive stance on the yield curve; we don’t want
to get caught having to reinvest only in the short-end.”
He added that core bonds would always be his organisation’s bread and butter, and he didn’t see this changing anytime soon. For investment teams at insurers, this means that high-quality corporate bonds and treasuries are in — and likely will be for some time.
For Cataldo, core fixed income IG bonds would also always be attractive, and he also mentioned public equity direct lending as a safe-haven, especially during difficult economic times. From his perspective, a “fight against the [US Federal Reserve]” was completely futile and detrimental, which is why he advised repositioning portfolios to generate liquidity during this intense inflationary period. “Our long-term investment theses were tested,” he said, referring to the year's rocky start. “The market is interesting right now, and you have to let it come to you.”
Since earlier this year, when the Fed's Chair Jerome "Jay" Powell spooked markets with an indication that interest rates would remain high, many insurers have noted that inflation was their number one financial concern for 2023.
These comments also come on the heels of the US insurance industry seeing largely bullish results in 2022, with many posting year surpluses and stronger Q4 revenues – after a lacklustre Q3 – but, critically, with unremarkable investment portfolio returns. 2022 brought high catastrophe (CAT) losses and a turbulent macroeconomic environment, so continuing market instability has been expected throughout 2023.
However, Cataldo said that he thought a forced recession from the Fed was extremely unlikely. “It would signal Powell’s early retirement,” he said. “The Fed is serious about their fight against inflation, and rates will stay higher for longer. That’s okay, because of the short-term opportunities it allows. But we can continue to expect tightening.”
Lohmeier echoed an earlier talk from former House Majority Leader (R) Eric Cantor earlier in the day, saying it would really come down to the upcoming Fed meetings in July and September and what was decided there. In the near-term, there was a lot of interest in the short end of the curve because of yield, he explained.
“The Fed can’t control [the long end] of the curve.
That’s where the opportunities are.”
However, “locking in attractive long-term yield with higher coupons is also a viable strategy,” he said. He felt that the long end of the curve was “actually pretty stable” for the next six months or so. “The Fed can’t control that end of the curve,” he said. “That’s where the opportunities are.” This was especially the case for longer-duration investors who are looking to lock in consistent value opportunities that will benefit from lower rates in the future.
Despite the fact that private credit has been a hot topic of conversation for months now, Diefenthaler urged caution and due diligence. “You need to know what you’re actually trying to do,” he said. “Private markets and credit mean different things to different people. You really need to peel [strategies] back to the basic building blocks and know your purpose.”
Returning to — and even re-evaluating — core investment principles to ensure they’re sound during difficult macroeconomic landscapes will never hurt, was essentially the takeaway.
Lohmeier continued that his firm’s go-to was really mortgage securities, credit, and real estate — and one thing he was concerned about was commercial real estate markets weathering the high inflationary landscape throughout 2023.
“Powell doesn’t like the boon from equity markets right
now; don’t get ahead of yourselves.”
Diefenthaler, meanwhile, cautioned against getting too caught up in equity markets during this testy period. “Powell doesn’t like the boon from equity markets right now; the commentary from him really jawboned,” he said. “Equity markets, don’t get ahead of yourselves.”
He advocated for a buy-and-hold scenario due to the fact that it was so tricky to call interest rates at the moment. “We’re seeing an extension in duration,” he again reiterated.
Cataldo added that he saw a dislocation between where the market was currently pricing the Fed, and “where the Fed [was] pricing the Fed”. It’s an ongoing dichotomy that the market has to deal with, he continued.
His advice to other Chief Investment Officers and investment teams in the audience was to be judicious about the risks they were taking and always be thinking about liquidity needs. Fixed income, he said, would consistently be a mainstay in portfolios. “There’s a tremendous amount of leverage to the fixed income markets, with opportunities to prune and reallocate on the edge.”
Because everyone goes for essentially the same returns in public markets, privates offered new value opportunities to those who have thoroughly done their due diligence and weren’t hasty.
Lohmeier urged attendees to consider private credit and commercial real estate debt. “You can get yield for the liquidity you’re giving up, and there’s a risk/return profile you just can’t get in public markets,” he said.
“If you can make something walk and talk and look like a
bond, people will invest in it.”
He echoed Cataldo’s fixed income appreciation, adding a touch of cynicism: “If you can make something walk and talk and look like a bond, people will invest in it.” Still, he said, regulatory regimes were another main concern and often put a damper on innovation for fixed income investors.
Ultimately, Cataldo said investment teams must remember they were part of a wider insurance organisation, so the preservation of surplus was key. “Our main goal is to support insurance operations and ensure we’re not introducing volatility.”
Don’t rock the boat, he seemed to be saying. “You really need to consider your manager’s track record and fees and how they’ve done in previous cycles. It all comes down to management,” he added.
Diefenthaler predominately agreed. His main conclusion expressed a similar sentiment: investment teams were the small wheelhouse of a much larger insurance function, and they should never forget the bigger picture. “It’s about how well capitalised you are as an entity and how confident you are in your underwriting performance,” he said. “You need to bring your whole enterprise to the table.”
For insurance investment teams riding the rocky seas of prolonged inflation in 2023, it’s about returning to the basics, encouraging stability, and considering short-term opportunities as shrewdly as possible.
