Insurance Summer Event: Q&A with Johanna Kyrklund, Group CIO and Lisa Hornby, Head of US Multi-Sector Fixed Income: Hedging inflation, geopolitics and AI
How to hedge near-term inflation and protect against geopolitical risk were just some of insurers’ questions at our recent Insurance Asset Management Summer Event. Here’s a snapshot of our investors’ responses
What were the key questions at Schroders’ Insurance Asset Management Summer Event on Tuesday 27 June? Schroders’ CIO Johanna Kyrklund and Lisa Hornby, Head of US Multi-Sector Fixed Income, began the session by setting out key market themes – and an outlook through the remainder of 2023 and into 2024.
The audience then voiced their questions to Lisa, Johanna and Head of Insurance Solutions, Patrick O’Sullivan. Here are some of the top questions – and responses.
Q: We’ve spoken about longer-term inflation and the UK’s higher inflation in the short-term. What can be done to hedge against inflation on a shorter-term basis?
Patrick O’Sullivan: “It’s tricky. Trying to find something that will print you next year’s CPI is difficult. So it’s best to take a strategic decision on embedding inflation hedging within your asset allocation, for example by making an allocation to inflation-linked bonds as part of your reserve asset strategy.
“Certainly the commentary from the PRA in the last week, particularly for non-life insurers, points towards a need to consider inflation exposure on the liability side. This may lead to the need to consider inflation hedging, perhaps a strategic asset allocation review and making a long-term allocation to inflation-linked bonds as part of your reserve portfolio.”
Johanna Kyrklund: “I agree, and if you look at longer-dated break-evens, they’re still not reflecting inflation risk. So in that sense there are assets you can by that still offer that kind of ‘free option’ if inflation becomes unhinged.”
Lisa Hornby: “I think central banks will let inflation run higher than in the previous decade. Not the levels we’re seeing today. In my view the Fed has to keep inflation probably closer to 2.5%: in the last decade it ran at 1.5%. If they do that, it means the level of rates in the economy is higher than we’re accustomed to. Real yields today are actually positive. We had negative real yields 18 to 24 months ago. So there is actually real inflation protection embedded.”
Q: On near-term risk, have events in Russia increased geopolitical risk, or resulted in any portfolio changes?
Lisa Hornby: “Events in Russia do increase macroeconomic uncertainty. We don’t have as clear a power position in Russia as we did prior to this weekend. Uncertainty and instability breeds volatility, and we should be prepared for that. We’re not exposed to Eastern Europe, so that is less of a risk for us. We do have a fair amount of liquidity in portfolios.
“Our view in general is that over the past decade central banks supressed volatility and were able to do that because inflation was very low. The next ten years will be about higher inflation, and more volatility.”
Johanna Kyrklund: “Trying to maintain a totalitarian regime, while also fighting a war, is going to stretch a nation’s resources. If you look at the past 130 years, revolution in Russia has typically been preceded by some form of international conflict. I think this does suggest we could be moving into some new phase for Russia.
“The challenge is that we in the West have little insight as to what’s really going on inside Russia. You can’t trade your portfolio based on that. But it’s a good idea to have assets in your portfolio that provide diversification. I mentioned commodities earlier, as a structural diversifier, not just because of inflation but because of the geopolitical environment.”
Q: Looking further out at a possible recession in the US. How would you be positioned for either a soft or hard landing?
Lisa Hornby: “A slowdown in the US is just another factor, just another example of potential episodic volatility. Think about what happened earlier this year: spreads in January, early February, got down to the very low end of their historical range. A month later, following the situation we had with US regional banks, spreads blew out 40%-50%. It was a very short window and a significant spread widening.
“You want to have liquidity in your portfolio to position for that volatility, because that’s what leads to return generation.”
Q: How could AI acceleration impact economic scenarios? Is it an economic trend in itself? Could AI make asset managers redundant?
Johanna Kyrklund: “The way AI could potentially change the scenario is if it leads to labour displacement. I’m not sure that will play out that quickly – by which I mean the next 12 months. We’re exploring the use of it in Schroders at the moment, and we think ultimately the way it’s going to add value will be in combination with other technologies.”
Lisa Hornby: “AI could bring an enhancement in productivity. We’re already looking at it on a firm-wide basis, seeing how it can be used to streamline decision-making. It’s still early stages and hard to understand how powerful it is. Will it help us do more with the same amount of resources?”
Joanna Kyrklund: “I think some uses could be on the client side. We’re used to customising large institutional mandates. But where it could be interesting is if we aim for mass customisation, as in using AI to identify the preferences of individual investors – and then potentially using tokenised investments to give them access to a level of sophistication currently only within reach of institutions.”
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