Insurance asset managers are renewing their enthusiasm for public fixed income as the asset class emerges from years of low yields and returns.
However, managers still continue to embrace the evolution of their portfolios in finding new opportunities in private markets, industry experts say.
David Braun, managing director and generalist portfolio manager at Pacific Investment Management Co., said in an interview that public fixed income has had a rough few years but is looking very attractive now.
He pointed out in particular the tiny yields in 2020 and 2021, followed by “horrible” total returns in 2022 when the Federal Reserve raised interest rates so quickly. For the year ended Dec. 31, 2022, the Bloomberg U.S. Aggregate Bond index lost 13%.
“Public fixed income has been dragged through the mud for the better part of the past five years, but we think that’s in the rearview mirror,” said Braun. “If you really look at the front windshield, public fixed income looks incredibly attractive right now. A lot of these custom benchmarks our insurance clients will pick … they’re highly investment-grade, maybe AA- (or) A+ average quality with duration between four (years) and six or seven (years), they’re yielding 5.5% to 6%. Yeah, so boring is back! If you get 5.5% to 6% on a high-quality liquid public fixed-income fund, a lot of clients are saying, ‘Why do you need to go chase other things?’”
“You had to go chase other things when the 10-year Treasury was yielding 50 basis points in August of 2020, a lot of people got out of their comfort zones and went into private investments that they may or may not have fully understood because the yields were more attractive,” Braun said. “Now we’re seeing more and more people say, ‘If I can get 5.5% to 6% here, do I really need to chase it and get out of my natural comfort zone?”
Traditionally, insurers have been very long-term investors with conservative portfolios due to strict regulations under state laws and the National Association of Insurance Commissioners, which require a high level of capital efficiency. That has often meant the significant majority of insurance company portfolios consists of investment-grade fixed income.
That dominance, however, has abated since the global financial crisis. During an extended era of historically low interest rates, insurers have had to seek higher yields in riskier assets, with life insurers particularly willing to do so because of the lengthy duration of their liabilities.
As of Dec. 31, 2023, the entire universe of affiliated and nonaffiliated insurance company assets totaled $8.5 trillion, according to the latest National Association of Insurance Commissioners Capital Markets Bureau special report on the U.S. industry’s cash and invested assets.
That total represented an increase of 4.4% from the $8.15 trillion in total assets a year earlier.
Gradual decline in traditional fixed income
While fixed-income assets still made up a majority of all insurance assets, that percentage dropped to 60.8% from 62.3% a year earlier.
Fixed income has seen its dominance of insurance portfolios decline gradually since the end of 2010, when the NAIC said approximately 70% of insurance portfolios was invested in fixed income.
The remainder of the asset allocation as of Dec. 31, 2023 was 13.9% common stocks, 9% mortgages, 6.3% schedule BA and other assets (nontraditional assets that include private equity, private credit and hedge funds), 5.5% cash and short-term investments, 1.6% contract loans, 1.2% derivatives, 0.5% real estate, 0.4% preferred stocks and the remainder in other investments.
Common stock investments saw the greatest growth from the previous year, when 13.2% was allocated to the asset class. The NAIC report cited the strong equity markets during 2023 for the growth. Its share has also risen since the end of 2010 when the NAIC said 10.3% of insurance portfolios were allocated to common stocks.
The report also said insurers, particularly life insurers, have been increasingly turning to mortgages and schedule BA assets as higher-yielding alternatives to traditional bonds during the long period of low interest rates following the global financial crisis. Their year-end 2023 allocations of 9% and 6.3%, respectively, were up from their respective allocations of 6.4% and 4.5% at the end of 2010.
Gregory Halagan, managing director and global head of insurance solutions at Oaktree Capital Management, said he thinks most U.S.-based insurance companies in the past few years have settled into a relatively advanced and diversified portfolio of private markets.
“Insurance companies in Asia, for instance, are just starting the journey of scaling that exposure, so in part it depends on which region in the globe you're referencing, but private credit has definitely been the area of the biggest growth,” said Halagan.
“Within private credit portfolios, most clients tend to think of a core-satellite approach to building a portfolio, with the core exposure being senior middle-market direct lending, while the satellite exposures are strategies that provide additional alpha or diversification,” said Halagan. “We're seeing continued interest in core direct lending exposure, but we're also seeing persistent demand for the more alpha-oriented strategies, such as asset-based finance, junior capital solutions and sector-specific opportunities like life sciences lending. We are increasingly seeing higher adoption of evergreen private credit structures, particularly within the core senior lending asset class, as a way to better manage the NAV (net asset value) of the portfolio over time.”
Big opportunity in evergreeen funds
Matthew Armas, global head of insurance at Goldman Sachs Asset Management, said the industry has been focusing for several years on growing access through those types of evergreen funds.
“Permanent vehicles, or evergreen vehicles which will invest in private credit over time, allow investors to subscribe to the fund, so they can put in an amount in a commingled fund style of investment that then can have some redemption features,” Armas said.
“Those redemption features typically have mechanisms to deal with the illiquidity of the underlying holdings, but it's designed to allow people to get invested faster, to allocate easier to these markets, and then to provide a mechanism to allow for liquidity subject to market conditions,” Armas said.
“You see these in the form of private BDCs (business development companies) in the U.S., which has been quite a big growing area for the industry. You're seeing it in versions of that in Europe. You're seeing interest in being able to include them in savings products that the industry is writing, like valuable annuity-style products. You're also seeing it in some 401(k)-style investments. So what I would say is it's about opening up the industry, opening up these asset classes to new styles of investors, and then providing some features that allow for easier access and easier exits, again, subject to market conditions.”
Armas added that the nature of the funds’ capital regime fulfills an industry need to redeem closer to their asset allocations.
When discussing other asset classes where insurance clients are currently finding value, Geoff Cornell, senior vice president and chief investment officer of insurance at AllianceBernstein, said insurers have the advantage of seeing value in markets that don’t necessarily seem appealing to other investors because of their long-term liabilities.
“Commercial mortgages are a perfect example. We are a buy-and-hold investor, and we tend to be at the top of the capital stack,” Cornell said. “There are a lot of assets in the commercial mortgage loan market right now that you know people look at and say (they’re) not going near those because of what's going on with rates, or what's going on with office or what's going on with retail."
“We actually see those opportunities as great entry periods to say, ‘You know what? We've been in these markets for a very, very long time. We understand the protections we need to be able to buy these at attractive rates.’ And when others step back and say, ‘I don't want to touch that,’ we tend to say, ‘Let’s look at it and see if, fundamentally, we think it's a good credit that we can buy.’”
