Insurance: Favouring fixed income with an eye on emerging private credit opportunities

We believe easing monetary policy and financial conditions will be a tailwind for the global economy and markets in 2025. In our base case, we expect continued global growth close to potential. Though a recession scenario is not expected, it remains a 15% risk case.

Central banks would like to get to “neutral”.

US: The outcome of the US election in favour of the Republicans should mean the US fiscal situation is likely to remain loose given lower taxes, while longer term growth and inflation expectations may rise – in the immediate aftermath we have seen pressure on longer term US rates and could see volatility continue as policy details emerge. Fiscal expansion will likely lead to long end underperformance in Treasuries, whilst the short – medium part of the curve will enjoy more “anchoring” benefits from monetary policy easing. Even if Fed cuts are delayed and a “higher for longer” backdrop ensues, this means that income/carry will continue to drive demand and performance. We see the bar for rate hikes as quite high and this level of yields provides strong income generation and a buffer to higher rates risk.

Eurozone: A cutting cycle is underway from the European Central Bank (ECB), and faced with further evidence of slowing, they appear to be increasingly concerned – but any notion of getting “ahead of the curve” at this stage is wide of the mark. Our view is that policy rates are meaningfully above neutral and, with the economy likely to stutter for the foreseeable future, the market still underestimates the pace and depth of rate cuts that will have to be delivered in the next 12-24 months. The threat of tariffs from the US could be favourable for Euro duration given the potential impact on exports and growth.

UK: In the UK, growth is a little better than last year but remains very low.  A post-election bounce has not really materialized. Inflation is normalizing and should fall further as pay pressures diminish. We believe the BoE are responding too slowly to the sluggish pace of the economy and weakness in Europe. UK bonds have performed somewhere in between Europe and US in recent weeks given fiscal concerns on the recent budget announcement.

Financial markets

On the markets side, we see solid growth fundamentals and easing policy are supportive of markets. However tight valuations continue to be a challenge.

We are underweight risk relative to benchmark in our Global Tactical Allocation Model, underweighting equities relative to fixed income, favouring US equities, and defensive sectors with quality and low volatility characteristics. In fixed income, we are underweight credit risk relative to benchmark and overweight duration via investment grade credit and sovereign fixed income, at the expense of lower quality credit sectors.

Fixed income

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. 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.

We are structurally positive on duration, given our expectation of slowing growth and conviction about continued disinflation. We continue to expect yield curves to steepen, as central bank cuts support short-term rates, and continued heavy issuance weighs on longer-term rates. 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 invest in these markets due to the geopolitical concerns.

Differentiation between economies and easing timetables is creating relative value opportunities in rates, curves and currencies. In this context we favour the flexible fixed income strategies which can grasp these opportunities.

Senior secured loans

In the speculative grades space, we continue to prefer senior secured loans over the high yield bonds due to the excess yield and the credit enhancement features of the loans. Loans have offered one of the best yields in fixed income, while providing downside risk mitigation by being senior in the capital structure and being secured by companies’ assets.

In the private credit space and in a context of yields volatility, we believe insurers appreciate the strategic flexibility offered by senior loans. Nevertheless, we believe debt provision to larger, more well-capitalised companies, known as the upper middle market, will be a more attractive space given the strength and stability of these corporate balance sheets.

Private credit

We continue to believe the current environment will lead to improved deal activity despite significant capital being allocated to the space. 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.

Commercial real estate debt is anticipated to remain highly attractive in both economic and capital-adjusted terms as well mainly due to an improving credit quality and the large set of opportunities. Though investment in the Real Estate will be favoured by the lower interest rates environment and can offer some attractive entry points, at this stage of the cycle we prefer the debt part of the capital structure to absorb the potential volatility of the market before a recovery or the agility of the value-add strategies.

Private equity

Broadly speaking, we encourage insurance clients to be selective in their private equity (PE) allocations in the current environment. Strategies that rely heavily on leverage may struggle to deliver strong risk-adjusted returns in the current interest rate environment. Growth equity and expansion capital strategies are our preferred sub-asset classes within private equity.

Key potential risks facing Insurers in the coming year

We view disinflation – and the subsequent lower interest rates – as a potential risk to the insurance business models and thus believe it is the right time to reevaluate opportunities on the private credit side. We allocate a 15% chance to a recession scenario which would threaten the profitability of credit assets. This prudent approach is the reason why we favour diversification in private markets via semi-liquid credit such senior secured loans with a bias for larger and well capitalised issuers, or senior real estate loans. This prudent approach is the reason why – in addition to government bonds – we favour diversification in private markets via semi-liquid credit such as senior secured loans with a bias for larger and well capitalised issuers, or senior real estate loans.