Economics

Schroders’ 12th Annual Insurance Investment Conference 2016

After an extraordinary year for politics, we had plenty to talk about, whilst our overarching theme was finding yield in a world where trillions of sovereign bonds still offer negative interest rates.

21/12/2016

Schroders’ 12th Annual Insurance Investment Conference 2016

We thank those who came along to our 12th Annual Insurance Investment Conference at Lloyd’s of London last Friday. We had plenty to talk about after an extraordinary year for politics. Our theme was how to find yield in a world where trillions of sovereign bonds still offer negative interest rates. Here is a brief reminder of what we discussed.

Economics: negative yields – how to stay positive

World growth should gently accelerate over the next two years, but risks remain:

  • President Trump’s attempts to reflate the US economy are likely to lead to stagflation, even if threats of a trade war with China are probably empty
  • In Europe, post-Brexit Britain also looks set to fall victim to stagflation, while rising political risk elsewhere will cloud growth and help prolong quantitative easing
  • Emerging markets are a bright spot, as improving fundamentals outweigh rising US interest rates; China still faces challenges, but economic and political policy should remain stable.

Fixed income: yield hunting – how value investing can help  

Historically low yields and income inequality have led to political upheaval, which could herald a shift away from measures to hold down interest rates.

  • In the US, the market is focusing on President Trump’s plans for tax cuts, higher infrastructure spending and greater aggression on trade
  • US interest rates are hard to predict: wages are rising, as is inflation in places, but deflationary pressures remain from demographics, global trade, technology and existing debt loads
  • In a yield desert, the US debt market looks less parched than others, but differences in returns between industry sectors are wide and turbulence lurks below the surface  

Limits to US rate rises mean yield will be the main return driver for fixed income. Diverse industry and security prospects makes a compelling environment for a value approach to US bonds.

Multi-Asset: investing in risky assets as an insurer – four challenges and a solution

Like other investors, insurers want to maximisereturns on their capital, but they face particular constraints:

  • Volatility has distorted traditional asset class relationships: they need to be able to allocate assets dynamically
  • Portfolios based on asset class allocations may over-concentrate risk: they should prefer to diversify by risk rather than by asset class
  • Capital as defined under Solvency II may not reflect real underlying risks: they need to screen out investments that are less capital efficient
  • Dynamic asset allocation can lead to capital volatility: they need to take account of capital requirements when allocating risk assets

Our solution is a dynamically managed strategy based on diversified risk factors that tilts exposures to meet prevailing market and economic conditions, while being aware of Solvency II requirements.

Emerging market debt: is 2016 the beginning of a post crisis era?

Emerging market (EM) debt offers a wide range of opportunities, encompassing an $18.2 trillion debt market in more than 50 countries.

  • 2016 looks like the aftermath of a classic EM crisis and there is good evidence that a recovery cycle has now begun in many countries
  • Currency collapses appear overdone, local bond yields sit around their long-term average, while spreads look too low and are likely to widen
  • Political change and reforms are leading to a more business- and growth-friendly environment in places such as India, Indonesia and Argentina
  • High-risk nations now include those in the Middle East and Turkey, as well as the likes of Nigeria and Venezuela
  • Two countries with improving fundamentals and attractive valuations are Brazil and Indonesia. Other countries with improving dynamics are Columbia, India and Mexico, although in China  headwinds still prevail

The fund offers long-only, low-risk exposure to EM debt and currencies, aiming to enhance returns, preserve capital and diversify risk, providing low correlation with equities, Treasuries and Euro government bonds.