Some insurance firms were already avoiding buying corporate bonds rated just above investment-grade – and last week’s inversion of the US yield curve will likely further strengthen their resolve about that strategy.
On Friday, the yield on the 10-year US Treasury bill fell below that of the 3-month note for the first time since 2007, in a development seen as an early indicator of a recession.
Daniel Blamont, head of investment strategy at London-based life insurer Phoenix Life, said his firm was resisting the temptation to go into triple B issues or those on the verge of downgrades.
“The key thing is to be aware that we could be close to the end of the cycle,” added Blamont, who helps run Phoenix's £15 billion ($19.8 billion) annuity book. “We need to remain disciplined in our sourcing of private assets and also our strategy for liquid bonds.”
The Hong Kong-based chief investment officer of a European insurance firm took a similar view when speaking to AsianInvestor in late December.
He has been avoiding US credit, citing a “huge movement of insurance capital” from higher-rated instruments into BBB bonds in order to maintain yield levels.
And this has taken place despite the fact that, “at a high level, we are expecting a bigger downturn than 2008 in the US credit market”, said the CIO on condition of anonymity.
Such a crisis could see a mass downgrading, with as much as one-third of triple B bonds falling below investment-grade. That would automatically trigger a sale for many insurers that are not allowed to own such low-rated fixed income securities, the CIO said.
Another Hong Kong-based insurance CIO was more sanguine, noting that his firm and many others can hold onto non-IG bonds if they feel they are good credits and likely to rebound. That would mean avoiding being forced to sell them potentially at the bottom.
On the private debt side, meanwhile, Blamont avoids covenant-lite deals – where covenant protection on loans is weakened in order to boost yields. “We’ve turned down some private deals this year that were just too aggressively priced,” he noted.
Others too are preaching caution. Traditional assets are “unlikely to provide a satisfactory outcome in this late-cycle environment”, said Van Luu, London-based head of currency and fixed income strategy at US asset manager Russell Investments.
He was speaking at a behind-closed-doors insurance investment forum on Tuesday, giving his outlook on credit and equity markets.
Luu saw the “crucial variable” as the timing of the next US recession and argues that 2020 is the “danger zone” in that respect, given the yield curve inversion and US fiscal policy.
Every US recession has been preceded by the inversion of the yield curve, with a lag between them of 10 and 20 months, he noted.
Moreover, current US fiscal policy – in the form of tax cuts – is adding 1% to 1.5% to US GDP growth, but that will go down to zero by 2020.
“What does [all] that mean for markets?” Luu asked.
Equities generally peak on average six months before a recession, he said, while credit markets do so about 20 months before the start of a recession.
“While it might be a bit early to sell out of equities altogether, I think it’s better to err on the side of caution at this very late stage in the cycle.” Hence Luu recommended cutting back on corporate credit exposure at this stage.
Rather than relying on mainstream bonds and equities, he added, it makes sense to take an unconstrained approach incorporating some alternative assets.