Liquid fixed income: reach for the unfamiliar to prepare for the unexpected

2024 was largely a favorable year for insurers’ bond portfolios, though performance was more mixed during the fourth quarter, with more duration-sensitive assets seeing the most weakness as global rates soared. Early 2025 has so far painted a mixed picture: Declining rates drove USD fixed income prices up across the spectrum, while (mark-to-market) losses continued for investors in longer-dated European Treasuries. Despite the rates market turbulence and rapid-fire US policy announcements, investment grade corporate spreads have remained stubbornly stable. Altogether, corporate bond yields remain significantly above their long-term averages, supported by higher rates.

In this tumultuous environment, insurers might be tempted to de-risk their portfolios and direct a larger proportion of new inflows into the comfort zone of domestic Treasuries and corporate bonds.² However, with escalating trade tensions and elevated geopolitical risks, we believe that no corner of the market is truly safe; it appears prudent to diversify more broadly, aiming for a truly global allocation, while sticking with an active, hands-on approach to portfolio management.

We believe that emerging market (EM) debt should be an integral part of this global allocation. While the barrage of US tariff announcements has dominated the headlines and sent shock waves across markets, emerging market fundamentals remain robust. The performance of EM bonds thus far in 2025 reflects broad resilience to macro risks that have caused volatility in other asset classes. While the outperformance of EM corporate bonds relative to US corporates impacts relative value comparisons, we maintain conviction that the asset class provides valuable diversification and a fertile ground for active portfolio management. Within emerging markets, the market reaction to macroeconomic uncertainty has been focused on distinct repricing of country- and issuer-specific risk rather than a broader selling of EM assets.³

For an insurance investor, capitalizing on dislocations requires both an active approach to portfolio management and a strong understanding of an insurance balance sheet. To access the full spectrum of opportunities in global fixed income while maintaining resilient balance sheets and deploying their regulatory capital efficiently, insurers could partner with specialist active bond portfolio managers that can tailor their approach to insurance-specific performance indicators, constraints, and objectives.

Spotlight on Asia: navigating a serpentine maze in the year of the snake

With new capital regulations and financial reporting standards rolled out across the region and geopolitical tensions roiling the markets, Asian insurers’ bond portfolios are increasingly getting entangled in complex and sometimes conflicting regulatory requirements and rattled by market volatility.

Asian insurance CIOs are facing ever-growing complexity in managing their fixed income portfolios, with challenges including the introduction of a new risk-based capital (RBC) regime in Hong Kong; the finalization of the forthcoming RBC regimes in Taiwan and Japan;⁴ the approval of the International Association of Insurance Supervisors (IAIS) Insurance Capital Standard (ICS) as the prescribed capital requirement for internationally active insurance groups;⁵ the ongoing enhancements to Singapore’s RBC 2 regime;⁶ and insurers’ efforts to align IFRS 9 classification and measurement of financial assets with that of insurance contract liabilities under IFRS 17.

A trusted partner can assist with navigating these complexities. Specialist fixed income managers can help insurers seize opportunities across the full fixed income spectrum – from local-currency bonds to Asian USD credit to global bonds – while tailoring portfolios to insurance-specific objectives and constraints.⁷ Insurers can leverage these partnerships further by prioritizing asset managers who can support them across the entire balance sheet and along all stages of the investment decision-making process, from helping to refine the long-term investment strategy, to educating boards and supervisors on new asset classes and innovative solutions in extended and alternative credit, to providing security-level portfolio construction, active management, and customized reporting.

Leveraged finance: staying active and agile

With mounting uncertainty about the global growth and inflation outlook weighing heavily on markets,⁸ insurers face a conundrum: Should they lock in current yields on long-dated bonds and ride out the mark-to-market volatility? Or boost their short-term income by parking more money in higher-yielding shorter-dated and/or floating-rate assets, and wait for rates and FX hedging costs to stabilize?

We believe that leveraged finance – across both public and private markets – is an appealing option in this highly uncertain environment. The US economy remains resilient, with steady GDP growth and inflation expected to trend toward the Fed target (despite a potential temporary rise due to tariffs). Leveraged finance issuer fundamentals are likewise still robust, with earnings largely meeting or exceeding investor expectations.

In this environment, leveraged finance asset classes remain an appealing option. Although credit spreads remain relatively low, all-in yields are historically attractive. With higher spread but little price upside in leveraged loans and investment grade (IG) collateralized loan obligation (CLO) debt, we believe all parts of leveraged finance have a similar risk/return balance for 2025 and would view any potential volatility event – such as sudden Treasury rate spikes or a correction in tech equity valuations – as buying opportunities.⁹

CLOs: full steam ahead

Despite limited new leveraged loan issuance, CLO issuance reached a record high in 2024 as managers took advantage of tighter liability spreads,¹⁰ offering active investors ample opportunity to deliver alpha from their CLO tranche portfolios.

In this environment, we continue to favor an active approach to portfolio management, including selective purchasing of shorter-spread-duration CLO assets across the capital stack, especially for lower-rated credits. If spreads were to widen, we would support shifting further into lower-rated tranches for portfolios positioned higher up the cap stack overall. High all-in yields and spread compression across the fixed income spectrum, coupled with turbulence in the IG bond markets, mean that CLOs continue to see strong demand from investors seeking income, diversification, and liquidity – and in particular from Asian insurers that are not constrained by the Solvency II standard formula’s onerous regulatory capital requirements and have some catching-up to do with their global peers.

The rising interest in CLO tranches among Asian insurers mirrors the trend set by their US and Bermuda counterparts. In recent years, CLOs have become integral to the fixed income portfolios for US and Bermuda insurers. In 2023, US insurers’ holdings of CLOs grew by 9.5% (in relative terms), reaching 5.2% of total bond holdings, up from 2.8% in 2018.¹¹ Despite extensive regulatory reform, in 2024 US insurers maintained their demand for CLO tranches.¹² Bermuda reinsurers have been keeping pace with their US peers, with a weighted average CLO allocation of 5.2% of overall investments for commercial long-term insurers at year-end 2023.¹³ Our conviction is that investing in CLO tranches should not be the sole purview of US and Bermuda insurers.

As a liquid floating-rate asset, CLO debt holds a universal appeal for insurers facing an environment of volatile rates and cross-currency bases and seeking higher yields without higher credit risk, alongside diversification with their longer-dated core fixed income holdings. In the post-global-financial-crisis landscape, robust structures and revamped credit rating criteria insulate the holders of IG CLO debt tranches from all but the most unlikely credit risk scenarios.¹⁴ For insurers outside the European and UK Solvency II perimeter, regulatory capital requirements for CLO tranche investments are amply offset by significant pickup in spread return on regulatory capital.¹⁵

While the asset class’s perceived complexity and the additional internal and regulatory approvals that may be required in more restrictive jurisdictions may be seen as deterrents, these obstacles can be surmounted with support from specialist CLO tranche portfolio managers that offer cross-border insurance investment and regulation expertise.

Private credit: swim with the dolphins, but mind the whales

Drawn by persistent spreads over comparable public assets along with stable valuations and strong creditor protections, global insurers showed a hearty appetite for private credit across the spectrum in 2024.¹⁶ At the same time, competition between the direct lending “whales” at the intersection of the private credit, leveraged loan, and high-yield bond markets continues to intensify. Alternative asset managers have been muscling their way into headline-grabbing high-grade mega-deals,¹⁷ global banks staged a comeback with stronger balance sheets¹⁸ (and potentially less onerous capital requirements),¹⁹ and major lenders of all stripes have been leaning into the wealth distribution channel with semi-liquid funds products – all against the backdrop of proliferating collaboration between alternative and traditional lenders staking out their claims on the “new frontier” of asset-backed financing (ABF).²⁰

Intensifying competition and rapid market expansion are undeniably good news for borrowers, who can expect to benefit from tighter spreads, more flexible covenants, and better-tailored capital solutions. For debt investors, this raises concerns about the ballooning size, concentration, and complexity of private credit investments. These concerns are shared by regulators that are staging a global push toward greater transparency,²¹ more rigorous stress testing,²² and enhanced risk management in private credit portfolios,²³ with a particular focus on indirect exposures arising from funded reinsurance.²⁴

In this environment, we believe that insurers should be more judicious and purposeful in their allocations to private credit. This could mean disciplined in-house origination complemented with focused offerings from specialist managers with a consistent track record of capital preservation, prudent underwriting, and transparent valuation. As competitive pressures and the pursuit of scale keep intensifying in the upper middle market,²⁵ clearly defined strategies such as lower middle market direct lending retain a strong appeal.

Spotlight on UK life insurers: keep calm and carry on originating

2024 was a strong year for the UK life insurance industry, with investment returns boosted by higher yields and regulatory capital buttressed by Solvency UK reforms. The median Solvency Capital Requirement (SCR) coverage ratio for the UK life industry stood at a healthy 215% as of third-quarter 2024, down from the record-breaking 225% at year-end 2023 but still far above pre-Covid levels.²⁶ Over the first months of 2025, listed UK insurers reported strong results and an upbeat outlook, with a strong capital position supportive of new business origination and higher allocations to return-seeking assets.

The pension risk transfer (PRT) bonanza has continued, with two new entrants in 2024 and at least one more anticipated this year. The industry achieved near-record volumes in 2024, with buy-in transactions reaching £49 billion and another £8 billion in longevity swaps.²⁷ PRT volumes are expected to persist at around £40 billion-£60 billion per annum over the next decade,²⁸ creating strong demand for matching adjustment (MA) eligible assets.

The scope of this future demand is evident from last year’s illiquid origination by life insurers, with firms deploying as much as 45% of PRT inflows into illiquid assets.²⁹ Anecdotally, insurers have also reduced their reliance on funded reinsurance arrangements for new business, reflecting both higher sterling yields and renewed scrutiny of funded reinsurance arrangements by the Prudential Regulation Authority (PRA).³⁰

How do UK life insurers sate their ever-growing appetite for MA-eligible illiquid credit given the finite domestic supply of suitable assets? One part of the answer is the highly predictable asset bucket and other measures introduced in the Solvency UK reform package.³¹ We believe that another part of the answer lies overseas. Utilizing strategic partners to source, structure, and manage suitable high-quality illiquid credit assets at meaningful scale, across all geographies and market segments, can help build diversified and resilient portfolios while meeting the requirements of the Solvency UK regime and the prudent person principle.

Infrastructure: Asian insurers’ golden moment

In 2024, Asian insurers were busy future-proofing their balance sheets against volatile markets, evolving regulations, new and emerging financial reporting and climate-related disclosure requirements, and persistent geopolitical tensions.

Compared to banks funded by fickle demand deposits, life insurers are well-positioned to earn stable spread income by pairing their long-dated liabilities with illiquid infrastructure assets that benefit from stable, long-duration, income-heavy cash flows (often with explicit or implicit inflation linkages), stable fair-value valuations, and a degree of diversification from traditional liquid investments.

Global demand for infrastructure to support generative AI, energy transition, and climate resilience puts global insurers in a strong position to deploy patient capital into long-dated assets that would also contribute to their environmental and sustainability goals. In Asia, new and emerging risk-based capital regulations give life insurers further incentives to source long-dated assets to back their technical provisions and offer reduced capital requirements for investments in qualifying infrastructure debt and equity.

For European insurers, the attractive risk profile of infrastructure has long been reflected in the lower Solvency II capital requirements for qualifying debt and equity investments. Following the enactment of the relevant regulatory amendments,³² European Economic Area (EEA) insurers’ holdings of infrastructure funds grew at an average rate of 25% per annum – while their total invested assets remained flat.³³ As of fourth-quarter 2023, EEA life insurers’ infrastructure allocation stood at 3.3% of their total general account investments.³⁴

Across Asia, lower capital charges for qualifying infrastructure are already embedded in South Korea K-ICS and in Japan’s (draft) economic value-based solvency ratio (ESR) risk-based capital regimes;³⁵ reviews of capital treatment of infrastructure investments are under way in Hong Kong,³⁶ Singapore,³⁷ and Taiwan.³⁸ This regulatory advantage is not yet fully reflected in insurers’ investments: the typical infrastructure allocation from the largest APAC insurers is estimated at about 1%-2% of total investments,³⁹ significantly below that of their European peers. Closing this multi-billion-dollar gap would require supplementing insurers’ in-house origination capabilities (typically focused on domestic and near-shore markets) with global asset managers’ origination and structuring expertise to deliver scale and diversification while navigating the intricacies of local regulations.

Global real estate: at an inflection point?

While the broad real estate market has probably broadly bottomed, any kind of meaningful sector-wide recovery isn’t around the corner – and more pain can be expected in the office sector before return-to-office directives help occupancies and valuations find a steady floor. We believe that in this environment, insurance investors seeking to capitalize on the inflection point should focus on sourcing attractive opportunities in partnership with experienced managers that can deliver on a business plan rather than just increase their broad exposure to the sector.

In the US, private commercial real estate prices may be near or past their bottoms, following a roughly 20% value decline from the mid-2022 peak.⁴⁰ An approaching wall of debt maturities following a flurry of activity in the multifamily housing sector during 2021 and 2022 (much of it funded with variable-rate debt) creates opportunities for new investments in the sector across the full capital stack. We believe that these opportunities may be more appealing in areas that stand to benefit from residents’ and businesses’ migration out of major coastal metropolises.

On the opposite side of the Atlantic, the UK property sector appears fairly valued, and the all-property yield isn’t likely to drift far from where it is today. For broadly diversified core real estate holdings, total returns will likely be dominated by income – but with higher bond yields, income can now be found in easier places. Aiming for attractive risk-adjusted performance would require thoughtful sector and stock choices, along with an ability to source distressed opportunities and deliver a business plan. In the eurozone, by contrast, falling interest rates (and pockets of growth, such as Spain) will attract income-focused investors back into the sector and potentially “stop the rot” in values sooner.

Listed equities: diversifying risk for global (re)insurers

Global property (re)insurers continued to bear the brunt of the global climate emergency in 2024. The hottest year on record⁴¹ caused $140 billion in insured losses, largely due to hurricanes and floods.⁴² Elevated claims were offset by firm pricing and higher investment yields, resulting in healthy returns on capital for the industry in aggregate.⁴³ However, 2025 brings new pressures: a softening reinsurance market,⁴⁴ devastating fires in California,⁴⁵ and – potentially – declining yields on new fixed income investments made at lower rates. These factors compel P&C (re)insurers to better allocate capital across risks and to seek new investment performance drivers while maintaining investment portfolio liquidity.

With elevated underwriting risks and volatile bond markets, an exposure to equities could provide attractive incremental return on economic capital, especially for (re)insurers that have so far prioritized liquidity and capital preservation by investing in high-quality fixed-income assets. For broad equity beta exposure, research-enhanced index strategies could offer a cost-efficient solution. For those seeking to fully benefit from the equities’ risk and capital diversification potential, long-short equity strategies can deliver uncorrelated returns without sacrificing the liquidity of their portfolios.