@Wikimedia Commons.
The return of Donald Trump to the White House is just the latest reminder that the optimism of the era of globalisation is firmly behind us. Trump’s focus on tariffs as a key weapon in his arsenal to deliver his pledge to “Make America Great Again” is another – possibly the final – nail in the coffin of globalisation.
That requires a refocusing of the investment lens, not least by insurers. It seems cautious conservatism will be their guide, putting fixed income assets at the heart of their strategies. They have closed the door on the years of cautiously exploring alternative assets in search for yield and have restored fixed income as the foundation of portfolios. In that sense, little has changed.
Within that refocusing on fixed income, however, there are a myriad of uncertainties and a divergence of opinion on how a Trump administration committed to tax cuts, infrastructure projects and tariffs will impact the markets. All eyes will be on US inflation, which is already looking as if it has bottomed out.
There is a consensus among economists that the shift in fiscal policies under the new administration will nudge inflation up further: the question is how far and how fast? And how will that influence the Federal Reserve’s interest rate policy?
Large infrastructure projects could inject growth into specific sectors – perhaps making some carefully targeted equity plays attractive – but will likely drive inflationary pressures. If tax cuts boost consumer spending they too could add to the upward pressures. Then there are the tariffs. If they unleash a global trade war, prices of goods imported into the US could start to rise sharply. These factors could alter the trajectory of US interest rates, already off their peak of 5.5% and widely predicted to come down to 3.5-4% by the end of 2025.
“Fixed income investments will continue to be a cornerstone
for insurance portfolios."
Offsetting these potentially inflationary pressures will be the promised deregulation which may reduce costs for many key sectors, such as energy – fossil fuel – production, technology – especially as the US races to lead the world in the development of artificial intelligence – and the financial services sector. Add to this the prospect that tariffs could boost some domestic businesses with little exposure to international markets, either as importer or exporter, and there could be further opportunities for some astute tactical investments.
This is unlikely to dilute the prominence of fixed income assets in insurer portfolios, said Charles Moussier, Head of EMEA Insurance Client Solutions at Invesco. “Fixed income investments will continue to be a cornerstone for insurance portfolios. With central banks likely maintaining a cautious approach to interest rates, fixed income securities remain attractive.
"Our anticipation of an improved opportunity set within distressed debt
means insurers may see more opportunities in this bucket."
Moussier added that in the current contraction regime, insurers will “probably reinforce their duration using governmental bonds rather than corporate bonds and look for additional income in the private credit universe”. This trend hinted that the prospect of an uptick in deal activity is also worth keeping close to as well as searching for opportunities in private credit.
“We continue to believe the current environment will lead to improved deal activity despite significant capital being allocated to the space,” he said. “As such, insurers should consider staying the course. Our anticipation of an improved opportunity set within distressed and special situations debt means insurers may see more opportunities in this bucket, which enhances capital-efficiency compared to the private equity bucket.”
The big debate for fixed-income investors will be around duration. Ratings agencies are also clear on the importance of retaining a focus on fixed income assets and the need to juggle with duration as interest rates shift.
A recent report from AM Best on what it described as improving prospects for the global reinsurance market summed up this challenge. “One of the motivating factors for the initial shift to the Positive outlook for global reinsurance was the sustained higher interest rate environment,” it said. “Not only has the higher cost of capital translated into stricter underwriting discipline, but as new money has been invested in higher interest rate fixed income instruments, reinsurers have gradually improved their investment income streams.”
“In this context the central banks of emerging markets will gain some
financial flexibility and increase the attractiveness of these markets."
The report continued by saying that although rates have declined, they remained higher than the rates on most of the older maturing bond issuances in reinsurers' portfolios. “Some reinsurers lengthened durations as rates rose, although non-life portfolio durations generally remain within three to five years,” it said. “With rising geopolitical tensions, the recent US elections, and general economic uncertainty, future interest rate trends are far from clear. However, reinsurers will collect relatively higher levels of dividend and interest income for at least the next three to five years.”
The duration game could play out differently around the world, said Moussier, creating opportunities for better returns, perhaps in markets not always favoured by the traditionally cautious managers of insurer portfolios. “We continue to expect yield curves to steepen, as central bank cut support short-term rates, and continued heavy issuance weighs on longer-term rates,” he said. “In this context the central banks of emerging markets will gain some financial flexibility and increase the attractiveness of these markets, but selectivity is key to investing in these markets due to the geopolitical concerns.”
Part of Trump’s response to those geopolitical risks is a stated determination to ensure the dollar remains the world’s principal reserve currency. This is a direct response to America’s fears about the growing influence of China across much of East Asia, South East Asia, and Africa. It will not be without its challenges for institutional investors, especially if they have been drawn towards including emerging market debt in their portfolios.
“A stronger dollar presents a challenge for emerging markets
with significant dollar-denominated debt."
Few CIOs will need reminding that a strong dollar can exacerbate vulnerabilities in emerging markets by increasing the cost and risk of US$-US$-denominated debt, leading to economic instability, inflationary pressures, interest rate increases and potential debt crises. In past periods of Dollar strength, such as the early 1980s, and during the "taper tantrum" of 2013, many emerging markets faced severe challenges. These included capital flight, currency collapses, and debt crises. Ironically, this might create opportunities for China to step in with promises of help, although this has often resulted in fresh heavy, inflexible debt burdens.
Institutional investors must be alive to these risks, says Ali Zane, a California-based credit expert. “A stronger dollar presents a challenge for emerging markets with significant dollar-denominated debt,” he said. “For US-based institutional investors with emerging market exposure, this could mean higher default risks and prompt a re-evaluation of foreign holdings, particularly in regions with high external debt. A hedging strategy becomes crucial in this environment.”
One of the biggest challenges facing insurers will be how to respond to the sharp divergence between the US and Europe on environmental issues.
In Europe, insurers are facing increasing pressure from governments and regulators to raise their game when it comes to responding to the climate crisis and hitting net-zero targets. Many major European insurers have announced a mixture of disinvestment from fossil fuels, especially coal, and a commitment to support the growth of the renewable energy sector. This has been encouraged by regulators such as the European Insurance and Occupational Pensions Authority (EIOPA) in the European Union and the Prudential Regulation Authority (PRA) in the UK. Both are challenging insurers to demonstrate that their underwriting and investment portfolios are resilient to the potential shocks of extreme events caused by climate change.
Across the Atlantic, the climate change debate was very much to the fore during the Presidential election campaign. Insurers already bear the scars of getting caught in the political crossfire from this and will be nervously watching for signs of the new administration’s stance. For European insurers with a significant presence in the US, this will be a nervous wait.
Last year, the insurance industry's ambitions to forge a global alliance to ensure it makes an effective contribution to the drive to achieve net zero carbon emissions crumbled in the face of threats from US lawmakers in Republican states.
The much-heralded Net Zero Insurance Alliance set up as part of an initiative launched by former Governor of the Bank of England Mark Carney at COP26, called the Glasgow Financial Alliance for Net Zero (GFANZ), collapsed as major insurers, reinsurers and Lloyd’s rushed for the exit door when 23 US state attorneys general rattled their collective sabres by threatening to take action against the members of the Alliance under US competition law.
The reasons cited by the Republican lawmakers contained many of the objections to tackling the impacts of climate change bandied about by American climate change sceptics and which have contributed to the growing momentum of the anti-ESG movement in the States. This narrative has found a fresh voice and many key figures in the new US administration are advocates of it. It stretches beyond just environmental and net zero objectives.
This will require a careful response on the part of insurers already committed to investment strategies balancing withdrawal from fossil fuels and investment in renewables, says Anuj Shah, Head of ESG at global consultancy Stax.
“The term ‘ESG investing’ can be misleading because ESG itself is not an investment strategy but an umbrella term for the data that tracks and measures a company's performance on material factors,” said Shah. “It's important to note that ‘material’ here means these ESG factors are significant to a company's financial performance. Investors can use – or choose not to use – ESG data as an input into their investment processes to assess risks and opportunities, but ESG in itself should not be considered a standalone investment strategy.”
For institutional investors with ESG mandates, this could require looking for innovative ways to invest in clean energy, even if the political environment turns more hostile. Changing the focus and language around this sensitive area could be helpful.
“In contrast, ‘impact investing’ is a specific, intentional strategy aimed at generating measurable and positive social and/or environmental impacts alongside a financial return. Impact investing strategies can vary widely, including investing in renewable energy projects, affordable housing, healthcare solutions, or education initiatives,” he said. “These investments are typically evaluated based on their ability to achieve targeted impact outcomes, which are often aligned with broader societal goals like the UN Sustainable Development Goals. Thus, while ESG data can inform investment decisions, impact investing explicitly seeks to create positive change as a core objective.”
Whether this subtle change of language and more robust financial justification will satisfy the new US administration and its supporters among the all-important state insurance commissioners is an open question. A lot will depend on where this sits in its priorities but expect caution to be the watchword for CIOs when it comes to their US portfolios. Pure play US insurers are likely to avoid it altogether. Multinational insurers will have to find ways of facing both ways.
One word that keeps recurring in analyses of the likely impacts of Trump’s return to the White House is “unpredictable”. That is one word that is always guaranteed to make insurance CIOs uncomfortable.
Time to fasten seat belts.
