Duration and Credit Quality: Where Can Insurers Find Opportunity in the Bond Market Amid Recent Volatility?
We spoke with New England Asset Management to discuss how insurers can approach their bond portfolios, via duration and credit quality positions, as a means of navigating the current investment environment.
SAA: Given the backdrop of central bank tightening in the face of a slowing global economy, how are you recommending that insurance entities manage duration within their portfolios?
NEAM: We’re much more willing to add duration to portfolios now than we were at the beginning of 2022. At the same time, we’re certainly cognizant of a number of factors that could drive yields upwards. Additional Federal Reserve rate increases and stubbornly elevated inflation could push interest rates higher while a potential economic downturn could pressure credit spreads.
However, with higher interest rates beginning to weigh on economic growth, we expect any further increases in interest rates to be more modest than those we’ve observed so far in 2022. In addition, while the current economic deceleration could lead to wider credit spreads, meaningful spread widening has already taken place this year. We’re currently recommending that our insurance company clients maintain portfolio durations consistent with strategic targets while taking advantage of what we believe to be reasonable opportunities to add attractive yields via purchases of intermediate to longer maturity bonds.
SAA: Do you believe there are particularly attractive opportunities in certain sectors or sub-sectors?
NEAM: Two of the sectors in which we’ve recently been active are residential mortgage-backed securities (RMBS) in the intermediate part of the curve and municipals in the longer end of the curve. In both cases, spreads have widened significantly this year. Moreover, we expect both sectors to be relatively resilient in the event of an economic downturn. The RMBS securities that we target benefit from U.S. agency guarantees or from credit enhancement that we believe comfortably exceeds potential losses in stress scenarios.
Many municipal issuers, meanwhile, have utilized significant federal government support to strengthen their financial positions in recent years. Spreads in the corporate market have also widened in 2022 and we’ve found some very good entry points there as well. However, we believe that many of the more compelling investments have arisen in the RMBS and municipal bond markets given the combination of higher all-in yields and credit profiles that we expect to remain resilient in an economic downturn.
SAA: How are you positioning portfolios from a credit quality standpoint? Do you believe that wider spreads are providing opportunities to increase credit risk or are you concerned about moving down in credit quality given the slowdown in economic growth?
NEAM: While we believe that we’re finding securities with attractive valuations in several segments of the market, we remain selective from a credit standpoint. In the corporate market, for instance, we’ve observed some decompression in credit spreads as some lower quality issuers have underperformed in 2022. While that presents some potential opportunities, we believe that investors should remain selective in taking advantage of wider corporate spreads given the appreciable risks of a more significant economic deceleration and additional spread widening.
We believe that less liquid market conditions are also creating some opportunities. For example, within the corporate market, new issues with elevated concessions offer the ability to achieve attractive yields without materially increasing credit risk. While we may eventually recommend increasing credit risk, at present we believe that reduced liquidity in many markets is offering us the chance to increase portfolio yield while still avoiding some of the lower quality issuers that could be pressured in an economic downturn.
The NEAM responses herein are not an offer to provide investment management services and do not constitute investment advice or a recommendation to buy or sell a specific security or adopt a specific investment strategy. Future results may significantly differ from any forward-looking statements made herein depending on factors such as changes in securities, financial markets or general economic conditions. Investing entails risk, including the risk of loss. In no event shall NEAM be liable for any damages, losses or liabilities in connection with the use of this information.
Source: Strategic Asset Alliance, New England Asset Management The information contained herein has been obtained from sources believed to be reliable, but the accuracy of information cannot be guaranteed.