The macroeconomic environment won't always be your friend when it comes to asset allocation. So said several top industry figures in a new report published by Clear Path Analysis.
The report, which covers the opening panel discussion at Insurance Investor Europe earlier this year in London, features Ashish Dafria, Chief Investment Officer at Aviva UK Life, Adam Ruddle, Chief Investment Officer at LV, and Wei Li, Global Chief Investment Strategist at BlackRock.
The trio gave their views on key considerations around inflation and interest rates in 2024 and what strategies they work on to avoid unnecessary risk.
Ashish Dafria: I am confident that I speak for the entire insurance investment community when I say that risk management is in our DNA and so I don’t feel that the risk management part is anything new or ground-breaking even the risks themselves aren’t broadly anything new either.
One area, however, that does jump out to me is sustainability. As a somewhat committed practitioner in it, I find the debate frustrating at times and it’s a little bit like a religion on whether you are either a strong believer or an atheist. In the insurance investment risk management lens, this is an area of significant risk and opportunities. Regardless of which side of the debate you come out on, there is something for everyone to do.
The other area that is very topical is around liquidity. I started my career believing in the cliché that insurance companies obsess about solvency when in reality they get into trouble for liquidity reasons. Again, being mindful of liquidity is the other risk.
As the risk premia have shrunk, the opportunity costs have changed on what liquidity means and the implication is that having higher liquidity is suddenly more attractive.
I would say that just because it feels like a new regime, it doesn’t mean that everything we do needs to be new. Collectively as an industry, we have had a growing exposure to investment in private credit and infrastructure debt, and many of these that we see as opportunities remain very attractive and are helping us to navigate that environment.
Adam Ruddle: I agree, we need to be mindful of liquidity and, whilst we are in a new regime, we should not throw the baby out with the bath water. Older ideas such as having allocations to index-linked gilts still make a lot of sense.
Commodities may start to become interesting, and you need to think about the investment objectives for a number of your funds, what policyholders and customers are expecting, and consideration of risks where there is no reward or upside. So, would you like to hedge all of your interest rate risk away and, if so, would you do that synthetically or physically? Liquidity is certainly an area in which you need to be wary about. There isn’t a lot of upside risk on interest rates in a number of strategies, they are sometimes when you want to take duration, but most of the time not, so important to hedge this in a liquidity-conscious manner.
Wei Li: So far, we have heard about private credit, infrastructure debt, commodities, inflation-linked gilts, and inflation-linked bonds more broadly, and I would agree with all of this. We favour these exposures in our strategic asset allocation.
At this juncture, our assessment of the macro environment is that it may not always be our friend when it comes to asset allocation. We are talking about ESP rates where rates are staying higher for longer, and so far this year consumers have been resilient, but for growth, if we look at the average of GBI and GDP, which are what [the government] uses to date recession, we have already experienced 18 months of stagnation in the US. Our expectations are for stagnation to continue to be the prevalent macro narrative so all of a sudden we are talking about stagnating growth and inflation going through a bit of a rollercoaster. Coming out of the pandemic, the rotation was able to take inflation down and, today, inflation in the UK is on the downside, but there is a limit to how far goods disinflation can take inflation down before some of the structural constraints bind the economy again, creating inflationary pressure.
If we look ahead, it is a somewhat challenging macro environment with stagnating growth, inflation rollercoaster and rates being higher for longer. Therefore, when we think about asset allocation, we’re trying to identify the mega forces that come on top of the broader macro environment as we think about how to generate additional return for overall portfolio outcomes and returns. Some of the mega forces that we have identified include the future of finance, thinking about the withdrawal of banks from lending, and what that means for private credit to step up in this space. This is why private credit is interesting.
Other forces include the transition and what this means for inflationary pressure as we go through an energy-constrained environment, and this is where inflation-linked bonds come in. Then there is the ageing population, labour force constraints, geopolitical fragmentation, as well as Artificial Intelligence (AI) and digitalisation and the opportunities and the explosive earning potentials those forces can bring to an otherwise challenging macro environment.
Macro may not always be our friend, but mega forces can be friendly, and this is how we are thinking about asset allocation - leaning onto those structural mega forces.
