Transcript: IIF Online: Halftime Report for Insurers & Risk Pools (Q2 '24)

Alton Cogert, CFA, CPA, CAIA, FDP, CGMA, President & CEO, Strategic Asset Alliance

Dan Smereck, Managing Director & Principal, Strategic Asset Alliance

Alton and Dan look back at the highlights and challenges we all face in the financial markets, and look ahead at the opportunities and risks in the economy for next year. They also share insights on navigating the complex and dynamic global markets as insurers work towards their financial goals and objectives.

This transcript has been edited for space, content, & clarity

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Capital Markets Performance

SAA: The real story is looking at the trailing one-year numbers and effectively everything is up except the 10-Year Treasury. So, we've seen inflation come down, we've seen expectations improve for a fed rate cut in equities, and risk assets have been on a tear.

The other important takeaway for the last trailing year is that correlations among asset classes are very tightly related, and so if we look historically, for instance high yield and equities have been much less correlated to the investment grade bond market. That is not the case over the last 12 months.

Consumer FInances

SAA: This is showing you the consumer in an aggregate balance sheet and you can see we have significantly more assets than we do liability. So, when you look at it that way, consumers are in extremely good shape.

Of course, it depends on where consumers sit on what their economic situation is income. Generally speaking, on the top right of this exhibit is that households' debt service as a percentage of their disposable income is still significantly lower from where it was before the great financial crisis in '08-'09.

Even though things are starting to creep up and the folks who are in the lowest income brackets are certainly seeing more stress, even though their wages are up, but so are their costs with inflation as well as interest rates on credit cards.

Fixed Income Yields & Valuations

SAA: Yields are so much higher; they're multiples higher from where we were. It's hard to believe just 2 1/2 years ago when you particularly look that the aggregate was 1.75% at the end of 2021 - That's still north of 5% today. So the same dollars being allocated are earning multiples of investment income from what they were just 2 1/2 years ago.

Credit Maturity & Default Risks

SAA: The typical thing that gets high-yield investors in the trouble - defaults due to not being able to refinance. And so this is also fondly called the maturity wall here. You can see the high-yield market things, there's not much worry in the coming years, but things start to pick up in '27, '28, '29 where that refinancing risk could rear its head.

You always have to be vigilant. There's going to be surprises. They'll be they'll be defaults. Of course, whether you're in bank loans, high yield bonds, etc., but generally speaking, they've continued to be low and you can anticipate the fact that even if they were to go to average, you're still in a pretty good place for that strategic allocation into higher yielding bonds than staying in investment grade as long as you have the surplus to support that over time.

Alternative Asset Correlations, Returns and Yields

SAA: Liquidity is not nearly as good, but you're being compensated for that. Assuming you have the surplus to do so, other things like core real estate, etc., have gotten traction with larger carriers and larger insurers - all for the goal of trying to diversify the portfolio and source their yields across different types of profiles to provide better risk adjusted returns, i.e. Better risk adjusted yields. For our client base, we've spent more time in direct lending.

Bank CRE (Commercial Real Estate) Assets

SAA: Concerns regarding bank CRE exposures continue to mount, especially for smaller banks, as maturities of approximately $1.5T are scheduled 2024-28. Extend (i.e., the loan) and pretend (i.e., hope fundamentals recover) is not a viable strategy longer term… To pile on, if one also considers the embedded unrealized losses of fixed income securities being held by the banking sector, the potential for prospective bank failures look more likely.

AI Investment, Adoption & Energy

SAA: Something that's talked about, but it doesn't get a lot of front presses. The amount of electricity and the demand for support of all the data centers on how that's going to be. The expectations are for the amount of data and terawatts to increase just over the next four years - it's porbably an underestimate to say we'll need almost two times the amount of power to keep at the current pace.

We're in the very early innings, but something again else to keep in mind of how that infrastructure and that ecosystem that forms around AI can produce surprises and/or investment opportunities.

Disclaimer: The information contained herein has been obtained from sources believed to be reliable, but the accuracy of information cannot be guaranteed.