Thoughts for 2024 – For Insurance Companies

EXECUTIVE SUMMARY

INVESTMENT

• Global rates – higher rates should mean higher long-term returns: In our view, the neutral rate, or level of real interest rates at which central bank policy is neither stimulating nor restricting economic growth, has shifted upwards. This raises the range in which central banks will be conducting monetary policy in the years ahead, with two key consequences: 
  – The potential for monetary easing in 2024 is limited, as policy is not currently as restrictive as many believe, leaving central banks only able to edge interest rates downwards. 
  – Tightening monetary policy sufficiently for it to truly tame inflation over the longer term is going to be difficult, as the impact on broader asset prices may become politically intolerable. 
  
  Bond yields have risen to reflect this new reality, and we believe higher yields create a positively skewed, asymmetric return profile for fixed income investment. If we are wrong, and the neutral rate has not changed, yields could decline sharply as inflation is brought under control – potentially generating significant gains for fixed-income investors. 
   
• Global inflation – sustainably returning to target is likely to be tricky: Inflation moderated in 2023, driven by the powerful statistical impact of base effects as food and energy price spikes following the Russian invasion of Ukraine dropped out of the year-on-year data. We believe 2024 should bring greater clarity on where the underlying rate of inflation is likely to settle – and at this stage, it appears likely to be above 2%. This is likely to create a dilemma for central banks as unemployment drifts upwards and calls for easier policy grow. Some may prove far more willing to adapt their policy frameworks to this new reality than investors currently believe, effectively allowing inflation to run at higher levels than in the past. 
   
• Investment grade credit – careful analysis is critical to maximize the yield opportunity: The yields available in investment grade credit have risen to levels comparable to those of the decade before the global financial crisis. In our view, this represents an opportunity to lock in attractive levels of income, but to really maximize returns we believe careful credit analysis will be key. There is the potential for significant divergence in corporate bond performance in the year ahead in an environment of slow growth and rising funding costs. 
   
• Municipal bonds – naturally complements US credit: For those investors seeking to take advantage of the yields available in corporate credit, we believe taxable municipal bonds are an asset class that are an overlooked opportunity that is systematically mispriced. Taxable munis offer similar yields to US corporates but have several advantages; many of these public corporations are virtual monopolies that deliver services with inelastic demand to the public, meaning the asset class has previously been more resilient to periods of sub-trend growth and has historically experienced extremely low default rates. 
   
• High yield credit – the new growth asset: For the first time in many years high yield is living up to its name, with high yield offering very high levels of income at a time when defaults are expected to remain contained. In the US high yield market, yields are now so high that they offer returns in excess of average long-term rolling 12-month returns on the S&P 500 Index. As long as defaults remain low as we expect, this offers an opportunity to contractually lock in returns normally associated with equity market investment in an asset class which has historically experienced significantly lower drawdown risk. 
   
• Structured credit – maximizing income in a risk averse way: For investors that don’t want to migrate up the risk spectrum, the floating rate structure of most structured credit issues allows investors to take advantage of higher interest rates in very short maturities without the duration risk implicit in fixed-rate bonds. Perhaps the most important feature of all, however, is the powerful payment waterfall structures built into the asset class that make them fundamentally defensive. This makes the senior tranches of structured credit issuers well placed to withstand a period of economic weakness that may result from the policies implemented by central banks to slow growth and reduce inflationary pressures. 
   
• Currency – navigating a less certain environment for the dollar: The global economy is slowing, but the US economy is still expected to grow at a more rapid pace than other developed markets. This, combined with higher interest rates, makes it difficult to bet against the US dollar. However, after a bull run that’s lasted more than a decade, the US dollar sits close to historical highs, and an unsustainable fiscal position has created a vulnerability. This sets the scene for a choppy backdrop against which we feel a tactical approach is the best option.

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