Insurance CIOs: top 2023 themes

2022 proved to be a volatile and difficult year for financial markets. The U.S. Federal Reserve’s aggressive rate hiking cycle drove negative returns for a broad swathe of asset classes. How are insurance CIOs managing their portfolios through this environment, and what key themes are expected to guide 2023? At a recent roundtable hosted by Nuveen, several top insurance CIOs and private markets experts shared their thoughts.

The state of the economy

Nuveen’s Chief Investment Strategist Brian Nick discussed the current state of the economy and Nuveen’s expectations for 2023. While we continue to see the Fed driving the market, the U.S. consumer remains strong. Overall, we expect a mild recession in 2023, with the Fed engineering a softish landing.

However, we do see some risks. Political brinkmanship is always possible with a split U.S. Congress, and the U.S. debt ceiling debate could return to roil markets.

How do our panelists see these economic developments? The consensus view is that the consumer remains strong, as does the labor market. This leads us to see a broadly healthy economy despite Fed tightening. And our insurance companies are looking at the market through a lens of tactical asset allocation. Large insurance portfolios do not turn on a dime, but the overall impression is optimistic, with valuations at a level where long-term capital can be put to work.

Positioning up in quality

For a while, our panel of insurers was repositioning portfolios to lean more heavily into private asset classes, reducing the liquidity profile. But recently the conversation has become more nuanced and complex.

Public valuations have fallen across the board in 2022, revealing many potential areas to place capital. As one speaker said, “As long-term investors, now is the time to take advantage. We don’t often make investments that are too exciting, but now is the time to find opportunities.”

And while some risk of mark to market volatility is acknowledged, overall, our panel sees repositioning opportunities due to return potential, depressed prices, and elevated yields. Our speakers have seen some growing appetite for higher-rated CLOs, as well as other structured instruments such as MBS that may yield upward of 5%.

Our CIOs ultimately agreed to be patient, remain focused on the long term, maintain liquidity, and take advantage of duration plays.

One CIO spoke to increasing their investments in real assets, with nearly one-tenth of their GA allocated to asset classes such as infrastructure, farmland, and timber. These asset classes are tied to physical assets and their valuations are highly correlated to underlying commodity prices, so their values increase when prices rise. These assets have the potential to act as an inflation hedge in a portfolio.

The panel also sees increased opportunities in investment grade corporate bonds, but with a heightened awareness around medium- and long-term liquidity. Liability products purchased in a lower-yield environment can be negatively impacted in a rapidly rising rate environment. Disintermediation risk is a growing concern, whereas in the post-GFC rate environment it was primarily academic.

The speakers expressed ongoing frustration with regulatory issues around certain structured products, with several commentators preferring to avoid the asset class entirely. Others took a different approach, investing all the way down the tranche stack of CLOs into CLO equities. The potential returns and the ability to invest in CLOs structured by wholly owned asset manager balancing the risk that this manager saw from buying lower-quality instruments. There is a significant ongoing industry conversation around the use of CLOs, with comment letters and discussions with the NAIC being considered.

Opportunities in private markets

Within private equity, valuations have fallen less than expected, and have held up better than public valuations, mainly because the less attractive investments have largely come off the market. Transactions focused on relatively defensive industries are seeing elevated multiples and larger equity contributions to fund those transactions.

However, challenges exist in private equity, particularly for smaller providers with few differentiated sources of capital. Conversely, investors with broader LP relationships are seeing a tremendous opportunity set with good risk adjusted returns. Across middle market private equity, we are seeing better quality deal flows with lower leverage. While there is a low appetite from some corners of the market, we believe deals can look attractive if underwriting is executed well and the structure contains adequate covenants.

Across commercial real estate, we see ample appetite for credit and liquidity risk. Our speakers see opportunities to take liquidity risk if the underlying assets are in the right sectors and have the right structure. Sell-side balance sheets are being challenged. When banks are not there to make mortgage loans and finance leveraged lenders like REITs, the need for liquidity increases and the corresponding premium climbs. However, a balance sheet with lower leverage can lend into that very easily, on more conservative terms with lower LTV ratios and structures to help protect against the uncertainty of the asset valuations.

By sector, Covid accelerated some trends. Office is now very challenged to lend into, while multi-family and industrial have significant tailwinds. Retail has finally repriced, and opportunities exist in that sector.

The infrastructure sector has seen a slow down in transaction volumes, but market valuations have not declined to the same extent. The market can be relatively opaque, but in terms of privates versus publics, publics looked oversold and started to appear very attractive. We also see value in privates, but balance sheets must be put together more carefully due to the lack of transparency. Our panel commented that debt has repriced ahead of equity, and large amounts of capital are ready to be invested.

Our private markets experts assert that investors should be compensated for illiquidity. Through the second and third quarters of 2022, that premium was less pronounced than it should have been, making it a good time to rotate into public debt. Now we can maintain good allocations in the corporate private placement market. The 144a market has seen tremendous opportunities in ABS and more structured areas.

Fundamentals now look robust. High credit quality names at elevated yields have led to a flight to quality, but without covenant deterioration.

Regulatory questions and ESG

Insurance portfolios are leading institutional investors to use ESG as a risk factor, across the enterprise level and more specifically at the investment level. The insurance CIOs broadly discussed the positive KPIs used to measure changes. The discussion also examined the broader sustainability frameworks being enacted at the enterprise level, with the panel split on a net zero commitment. One firm did not want to make the commitment without a clear guide path to net zero, while another firm had made the pledge before seeing the complete path.

We had a frank discussion about some U.S. states acting against asset managers that have been at the forefront of the responsible investing wave, and uncertainty over the future of state regulations potentially acting as an impediment.

On the enterprise level, one panelist spoke to the difficulties of aligning employees and shareholders. But on the investment side, the firm has enacted a six-pillar framework. The debate was heated over whether to divest and exclude sectors such as fossil fuels and tobacco from portfolios or to help those companies move into a more sustainable direction. There are also fiduciary considerations to consider. One panelist asserted that by moving into certain asset classes such as timberland and farmland, sustainability can be built into the portfolio without sacrificing returns.

One final question remained somewhat unanswered: How do we tie ESG considerations to product and customers? How can ESG be a part of the sales conversation without encountering further regulatory issues.

Final thoughts

The final question of the day considered what the market might be missing. The top concerns included:

• Geopolitical risk. The ongoing conflict in Ukraine is continually threatening to escalate. Regarding China and Taiwan, the panel sees an invasion as an outside possibility, but it would have far-reaching consequences.
• Deglobalization. Risk stems from the fracturing of traditional capital flows and supply chains, as well as strained economic groups such as the eurozone post-Brexit.
• U.S. politics. Recent polarization has consequences for both the domestic agenda and global coordination.