Episode 287: The Next 10 Years: Key Trends Influencing Insurers' Asset Allocation Decisions

 

Stewart: Welcome to another edition of the InsuranceAUM.com podcast. My name's Stewart Foley, I'll be your host. Hey, welcome back. It's great to have you. We've got a phenomenal podcast for you today. Before we get going too far, I want to remind you that we have an ABM Real Estate and Infrastructure event in Philadelphia on May 7th and 8th. If that's your area of expertise, please email us at events@insuranceAUM.com and we'll get some information headed your way. The title of today's podcast is ‘The Next 10 Years’ Key Trends Influencing Insurers Asset Allocation Decisions’, and we have a terrific guest for you today who is Anwiti Bahuguna PhD, who is the Chief Investment Officer of Global Asset Allocation at Northern Trust Asset Management. Anwiti, thank you so much for being on. Thrilled to have you and look forward to a great podcast.

Anwiti: Stewart. Thank you for having me.

Stewart: It is our pleasure and we want to start it off the way we always do, which is where did you grow up and what was your first job, not the fancy one.

Anwiti: So I grew up in New Delhi in India, spent my first 20 years there doing my bachelor's in economics and mathematics. And, my first job was actually in the summer of 1988 where I was hired by one of my professors along with two other friends to go door to door in the huts of Himalayas and collect survey information from the women who don't come out and talk to men that often, Stewart. So we donned very traditional clothes and spoke in Hindi and spoke to these women about their household habits; who econ and history professors were collecting data on for their research.

Stewart: That's interesting. And it's fair to say that your PhD is in economics from Northeastern University. Can you tell us a little bit about how you got into the seat you're in today? I think it's helpful for members of our audience who are earlier in their career in particular to kind of understand how it is that you achieved this level of success, and just some background would be helpful.

Anwiti: That's a great question. I can tell you that when I started my PhD, this is not where, Stewart, I thought I would end up. So I come from a very academic background. Both my parents were academics, one in linguistics and the other in economics. Actually, my mother was in contest, and I thought I would follow their footsteps, get a PhD and teach in a university somewhere. So I did actually teach at Northeastern for a couple of years while I was working on my thesis. During that process, I realized that I absolutely loved applied work more than research that didn't go anywhere and sat in a research paper that three other academics read. So it really meant that I should join either policy work, and I got an offer from a bank in the northeast called Fleet Boston Financial to come and help them do strategy work. So that was sort of my start in the banking industry and as I was doing strategy work, I realized I really liked the asset management industry because, Stewart, that was an area where I could actually use my economics and market information and really do something for clients, creative solutions for them. So it ticked all the boxes in terms of my skillset, matching things that get my juices flowing.

Stewart: That's terrific. Let's start with the northern trust market view formation, which is under your purview. Northern Trust has experience across a broad range of asset classes, both public and private. Can you walk us through how your team formulates the market views and the value of incorporating perspectives from practitioners across different disciplines?

Anwiti: Sure, and Stewart, today I actually want us to focus on our longer term market views. In other words, this is a capital market assumptions exercise where our team looks at what we think likely will happen for different asset classes over the next 10 years. These we call capital market assumptions and they go into designing asset allocation portfolios for our clients. These are very different, Stewart, from our sort of 12 month outlook or tactical 3 to 6 months outlook. And hey, nowadays people are focused on the weekly outlook given all the chaos that's coming out of DC at the moment. But I wanted to set the stage and say I'm here to talk about our 10 year outlook, which goes into formulating portfolios for our clients. So these outlooks are really saying that if you just wanted a set it and forget it sort of portfolio and tune out the monthly noise and not worry about it, what should you expect from different asset classes and knowing what you would expect from different asset classes, how should we structure a portfolio?

And for that, typically if you look at other consultants in the field, they typically have a very structured process where they're looking at risk premium between different asset classes and coming up with what I would call a mechanical or quantitative way of looking as asset classes. In other words, for example, in fixed income they'll say there's a risk premium for taking on credit risk. So investment grade should be giving you higher returns than treasuries or high yield has even more credit risk, default risk. So high yield should be giving you higher return than investment grade. So these are all sort of, I would say quantitatively defined relationships and one could just look at history to come up with that, similarly in equities. But my team has a very unique process where they first meet and do the quant work themselves and say, okay, if we didn't know anything about the fundamentals of the world, if we just were looking at data, this is how we think returns would look like.

But in reality, we have at Northern Trust Asset Management, amazing practitioners in equity space and fixed income in private credit, in private equity, other alternatives. Why don't we all sit together and say, hey, this is what data tells us should happen, but what do you see different in the world right now that makes you think that some of those historical relationships don't hold anymore or we should expect something different going forward and let's sit together and formulate a view for the world for the next 10 years together that incorporates that fundamental thinking along with our understanding of the quantitative structure of markets.

Stewart: That's super helpful. If we turn our attention, to macro investing themes your team has identified three key macro themes shaping the investment landscape over the next decade, and they are AI enabled productivity, navigating the energy transition and globalization: ‘bent but not broken’, which I think is a really interesting commentary and I want to hear more about that. Can you give us an overview of these themes and their potential impact on insurance investors, which that's our entire audience?

Anwiti: Sure. I think I'll start with the one or two which are really quite relevant. Actually all of them are relevant for the insurance industry. But let's start with the first one, Stewart, which is on AI and productivity. And this theme's been prevalent in the markets for a couple of years, but really the genesis of that for us macro thinkers came from the fact that for the last 10 years or so, we've been hearing a lot about demographic drag in the developed world. In other words, we've had two decades of the demographic disaster that Japan was really in terms of birth rates being very low. And, ultimately, that translates into the amount of labor force you have available as workers in the economy. The fear was that Europe is going the same way. We have seen similar low birth rates in Italy and France, and the discussion was is it coming to all other developed economies?

Are we going to see that in the US also? And to be fair, US birth rates have also been coming down. What we have seen different in the US is that we have a robust immigration policy system, so far, that allows a lot of immigrants to come in and join the labor force. I can count myself in it as an example of that. How can we then as developed economies think of maintaining the level of strong growth and wonderful capital markets that we have in the west if we are facing the challenges of this demographic down drift? And what we found is that found that there are really good positive things to look for through the AI channel that can improve productivity. So even if we have fewer workers, they're working better and producing more. So a lot of estimates on what that AI boom can mean for adding to productivity and to US growth prospects.

We have seen already a lot of capital spend in this space. You are seeing people invest in growth stocks that benefit from this theme. And one thing we don't know is exactly what that exact contribution to productivity will be. The estimates out there are fairly wide. MIT professors have said that it's about 0.5%. Goldman Sachs team calls that number closer to 9%. So the range is wide from 0.5% to 9%, but we know that there will be some enhancement to productivity of workers through this AI channel and we want our investors insurance included to be invested in that space to take advantage of what these stocks offer. And in translating that then in the fixed income space Stewart that actually means that we have better growth prospects, we have better productivity, we have better higher neutral rate for interest rates and better returns for interest or fixed income focused investors also.

So the second thing we talk about is near and dear to insurers in many ways, and that is about the fact that we are seeing a world that's grappling with energy transition in other worlds. We are very aware that there are limited sources of energy as we knew it, and we need to look for new sources of energy and we also need to deal with what that changing environment means for the existing energy sources. So investing in clean energy, investing in areas and infrastructure that supports that energy will be a theme to focus on. And sort of tying it back to AI, even the need for AI requires more energy. So we are seeing interest back in nuclear energy, Stewart, because AI generation requires so much energy. So these are themes that I think will persist for several years and investors should have exposure to these themes.

Maybe it's through alternative energy sources, maybe Stewart, it's through just listed infrastructure because infrastructure is in demand for something like this. And then finally we spend a lot of time thinking about globalization. We have been hearing the phrase deglobalization for a very long time, and I'm a data nerd and I want us to see and have it proven in data that indeed trade flow is slowing down. And we didn't quite find that in data. What we found was that global trade numbers are still going up, but we are seeing that there is now different partnerships for me. So for example, if you defined deglobalization simply as US doing less trade with China, that is indeed true and that's showing up in data, but that's not deglobalization because US is doing more trade than with Vietnam and with Malaysia and Mexico. So these trends made us think that we don't want to use deglobalization as a phrase. We actually want to call it globalization bent not broken. In other words, we are still seeing global alliances being formed, we're still seeing trade happening. They're just with different, and we just need to know as investors, who are we trading with? Where are our companies getting revenues and make sure we have those exposures.

Stewart: That's super helpful. You had mentioned fixed income earlier, and I think that no insurance conversation is complete without talking about fixed income. It's a major part of, I would venture to say all insurance companies and you can't use all and insurance companies in very many sentences because they're so bespoke. But given the expectations for higher bond yields, that seems to be the consensus, a steeper yield curve. How should insurance investors think about fixed income allocations in this environment and how does Northern Trust view credit spreads and high yield opportunities in this market?

Anwiti: Stewart, I think in terms of fixed income only, this is a great environment for investing because the yields are so much different than what they were the last 15 years or so. So hearkening back to my 30 years in the industry, roughly, we are sort of going back to the pre GFC sort of environment for fixed income. In other words, if you recall, 2008 was a game changer for fixed income investors where interest rates went to zero, not just in the US but in most developed markets. And those who were playing in the fixed income space only had to work really hard to make their return targets. And in the fixed income space, returns are primarily 90% of the time driven by what's happening to the yield that you're getting. Yields on investment grade bonds similarly went very close to those low yield numbers, and it was a very low yielding environment for decade or more that all changed post covid when there were inflation fears in the marketplace and central bankers globally raised interest rate.

So I think we are at that phase where interest rate environment is such that fixed income gives you pretty close to the returns that you might be targeting. For example, returns just on investment grade in yield space are close to 4% or 5%. That's a very solid return and one doesn't need to go into arcane areas of the marketplace to get that return. You can see that if you're willing to take a little bit more risk, you can actually add to returns even more. Our return expectations for high yield is the strongest it's been in a while and actually pretty close to what might expect from equity returns if you're getting returns in the 6%, 6.5% range. So really great time for insurance to get solid yields with not going out too far out in the risk space.

Stewart: That's super helpful. One of the things that it's not often recognized is that property and casualty carriers often have a fairly significant equity position, not so much for life, but it would turn the topic here to equity market sustainability. Equity market returns have been exceptional over the past decade, but many investors wonder if that's sustainable. How does Northern Trust assess future equity return expectations, and what should insurance companies keep in mind when they're allocating to equities?

Anwiti: Great question. I think Stewart, if I look at the last 10 years, if I was sitting 10 years ago and forecasting equity returns for US stocks, I think the number would've been around 8% or so. In fact, what we realized was close to 13%. So this was a remarkable period of returns for equity investors. I would say though that those returns were fairly concentrated in the US space, excluding US developed markets didn't fare as well. And of course em had a challenging few years also, particularly if you look at the last two years, equity returns have been so strong that your question is top of the mind for many investors. In other words, can we really get 22% returns two years in a row? And I feel fairly confident saying that that's quite unlikely you had this AI driven growth focused market, but the market's starting to broaden within the US and internationally also. And so returns are likely to normalize to the long-term norms, which are still in the 7% range or so for a very global index and maybe around 7.5% or so for the US and closer to 7% or so internationally. So returns are better, but I would say it comes with volatility. As your investors are aware, if you are stepping out of the fixed income space, equities will give you potentially higher returns over periods of time, but you may have to sit through days where those returns are quite challenging if you're marking your books.

Stewart: That's helpful. So the next topic here is real assets and inflation hedging. And, insurance companies, their liabilities are exposed to inflation and sometimes that's medical inflation in the case of workers' comp carriers and others, which typically runs considerably higher than core inflation. So with that as a backdrop, inflation is still a concern for many investors. How does Northern Trust view real assets as an inflation hedge? And further, how should investors think about accessing these asset efficiently, particularly when considering instruments like ETFs versus private market options?

Anwiti: Sure. I think inflation became very much news only in the last 2 years or so, Stewart. So we went through zero interest rates and the fed's focus, if you remember, was to fight deflation really to make sure that we at least got to 2% inflation where we were operating in the US at around 1%, 1.5%. Now the tables have turned. We are looking at around 2.5%, 3% inflation. And the fears are that we don't quite know what happens with tariffs. Those numbers may get stickier. How do we think of the next 10 years and what if there is an inflation persistence? How does one make sure that we have a portfolio that can protect us through inflation? Also, because as predominantly fixed income, investors would know bonds don't always provide protection against inflation. So as bond investor, it is important to have real asset exposure. We particularly like exposure to natural resources where I would say the proxy commodities and provide protection to the portfolio. In other words, we see folks sell out of other growthier exposures and go to natural resources when there are fears of inflation. Similarly, exposure to listed infrastructure provides protection against inflation. And for both of those two asset classes per se, we have publicly listed ETF exposures available. Of course, one can go to the private space also to get similar exposures, but going into the private space, it's very important to know your managers.

Stewart: Yeah. You're helping me transition to the next question, which is private markets and insurance portfolios. Insurers, especially life insurers have embraced private credit for the yield pickup, and there are reasons why that yield pickup exists, but how should they be thinking about private equity allocations today and what role do secondaries play in helping insurers achieve diversification and vintage year balance? And that's a fairly specific question about private equity, but I would say you just talk about private markets generally and how you view that.

Anwiti: Sure. I think private markets, Northern has had experience in them for over two decades, Stewart, right? So they're not a new asset class by any means to investors. What I would say is that actually the 2022 experience where all your bond investments mark to market had negative returns, your equity investments had negative returns, really sparked a new and interest in, okay, if it's not stocks, if it's not bonds, where does one get exposure? Is it in real assets as we discussed, which gives inflation protection? Or are there other asset classes which give you some protection from the volatility that you're seeing in the public markets? And of course, we saw some of that happen in the private space and in the private space that's happening both in private equity and in private credit. So private equity is always been there to support smaller companies which have had difficulty accessing credit in the public space through banks and supporting venture and supporting IPO activity.

And all that's always been present in the market for the last two decades. I think private credit has taken on a whole new space in the alternative markets predominantly because we are finding that banks are pulling out from investing in that space. In other words, we are finding that the regulatory environment has gone through see change in the last decade or so, and it's much easier for companies to get access to credit in the private market than to go through the public markets. So slowly there is a transition that's happening in the capital market away from public to private. And as investors, one should make sure they have exposure to those areas also because that's the trend that we believe strongly is likely to persist in the private credit space. Return expectations for us, Stewart, are 8.5% or so. That's well above what you would get in any fixed income instrument. You're still getting exposure to credit, you're still getting exposure to good managers. You can be selective in that space, and the return potential is much better than ever before. Private equity has even higher return potential. But I would say it's imperative to make sure you know your managers in that space very well. People with experience, people with the right exposures, people who understand how to operate in that space is very important.

Stewart: It's been a phenomenal education with you and talking about the next 10 years, key trends influencing insurers, asset allocation decisions, and I appreciate you being on so much. I've got a couple of fun ones for you out the door, if you'll indulge me. The first one's not so much fun as it is informative to people who are younger in their careers, and the question goes like this, what characteristics, not necessarily skills or major or whatever, what characteristics are you looking for when you're adding members to your team? Can you talk to us a little bit about that?

Anwiti: Sure, Stewart. I think I've been thinking about that a lot and talking about that a lot with my team as we have been growing my team quite significantly the last year and a half. I think it goes beyond sort of the starting point, the question that people should have the appropriate skills. In other words, they should have the right degrees that one needs, that just gets your resume in through the door. That doesn't get you selected, though. And the number one thing I look for in selecting the members to bring to our team is really how they interact with other team members. In other words, how do they treat not just the senior people who are interviewing them, but their cohorts and people who may be actually reporting to them? That interaction to me is key because we want to make sure that these are the people we spend 40 hours a week within the office and can work with.

And then I would add a corollary to that if I may, Stewart. The second thing I'll add is that I also tell my team that every job is a sales job. In other words, it doesn't matter whether you are a researcher pouring over actuarial data all day, building spreadsheets. In the end, it's your job to convince someone that your analysis is worth paying attention to. So by a sales job, I mean is that everyone should be very good at communicating their ideas, whether it's to team members, whether it's externally, it's irrelevant. Ability to communicate is key in the people we hire.

Stewart: That's really helpful. So the last one really is fun and it goes like this. You can have lunch or dinner with up to three guests alive or dead. Who would you most like to have at your lunch or dinner table? Doesn't have to be three. Could be up to three, but your pick.

Anwiti: Wow, that's a tough one. Yes, I think I like a big dinner table for that, Stewart. I'll start with my number one pick, though. I'm a history buff. I've been reading Edmund Norris's trilogy on Roosevelt, Teddy Roosevelt, not FDR, and it's three books. The first one actually won the Pulitzer Prize. It's absolutely fascinating. I cannot put it down. So I would actually love to sit down with Teddy Roosevelt for dinner because he was amazing. Talk about a Renaissance man. So yes, that would be my number one pick to have dinner with at the moment.

Stewart: He is the person that came up with the quote about the person in the arena versus the critic in the stands. And I love that quote. I just think it's one of those things people say, “Hey, I'm going to start a business and I want to do this and I want to do that.” When you actually get out there and do it, it's a whole lot different program and I really admire, really appreciate that quote from Teddy Roosevelt. That's a really interesting choice. Is just one for you this time.

Anwiti: I could go on, but it'll, there are so many fascinating people. I watched Oppenheimer on the plane.

Stewart: Oh, amazing.

Anwiti: Into Los Alamos. I would love to have dinner with Oppenheimer. That would be amazing also.

Stewart: Yeah. Amazing.

Anwiti: What a complex character. 

Stewart: Very interesting.

Anwiti: So yeah, those two come to mind.

Stewart: I appreciate you being on so much. Thank you. And we've gotten a phenomenal education and gotten to know you a little bit. So thanks so much for taking the time with us.

Anwiti: Thank you.

Stewart: We've been joined today by Anwiti Bahuguna, who is the Chief Investment Officer of Global Asset Allocation at Northern Trust Asset Management. Thanks for listening. If you have ideas for a podcast, please drop me a note. It's Stewart@insuranceAUM.com. Please rate us like us and review us on Amazon, apple, Spotify, or wherever you listen to your favorite shows. My name's Stewart Foley. We are the home of the world's smartest money at InsuranceAUM. And this has been the InsuranceAUM.com podcast.