Different asset allocators often have varying objectives that shape their investment allocation decisions. For instance, institutional investors such as protection and indemnity (P&I) insurance providers may prioritize shorter-term fixed-income investments to match the shorter-duration nature of their liabilities. Norwegian maritime insurer Gard, the largest P&I player in marine shipping, exemplifies this approach by maintaining a significant allocation to fixed-income assets across the spectrum, including government bonds, high-yield bonds, and private credit, among others, whilst maintaining a relatively low duration.
“Similar to many insurance companies, we hold significant fixed-income allocations due to the nature of our liabilities,” says Thor Abrahamsen, Senior Investment Executive at Gard. Between 65 to 75 percent of Gard’s $2.6 billion investment portfolio is allocated to fixed-income investments, spanning investment-grade, government bonds, global high-yield loans and bonds, emerging markets bonds, and private credit. However, Abrahamsen observes limited attractive opportunities within the fixed-income space in the current environment.
“Spreads on both investment-grade and high-yield bonds are approaching all-time lows. Investors are still somewhat compensated for the risk, as historical default rates remain relatively low.”
“Spreads on both investment-grade and high-yield bonds are approaching all-time lows,” observes Abrahamsen. “Investors are still somewhat compensated for the risk, as historical default rates remain relatively low.” He goes on to emphasize that since we have not yet experienced a credit cycle, “should the market take a downturn, there is significant potential for volatility in these spreads, which could negatively impact fixed-income portfolios.” Abrahamsen further asserts that government debt is particularly unattractive in the current environment. “For instance, a 10-year Treasury yield of 4.2 percent appears too low, particularly if inflation proves to be more resilient than the market expects, or if current fiscal policies continue.”
Corporate Credit and High Yield
Shifting the focus to corporate bonds, Abrahamsen notes that “high-quality corporate credit remains attractive on a fundamental basis compared to government debt.” While he does not deem this segment particularly appealing due to low spreads, “it is still preferable to hold high-quality corporate credit over government debt.” Examining the high-yield market specifically, Abrahamsen notes that “historically, high-yield bonds have been attractive because their spreads generally compensate for the higher default risk. In net terms, investors are still coming better off as current spreads in the high-yield space are around 300 basis points.”
“Historically, high-yield bonds have been attractive because their spreads generally compensate for the higher default risk. In net terms, investors are still coming better off as current spreads in the high-yield space are around 300 basis points.”
In a diversified portfolio, the current level of spreads is sufficient to protect investors from a typical default cycle, according to Abrahamsen. However, he points out that spreads are highly sensitive to changes in the broader market, which makes this segment “less attractive,” particularly given the ongoing interest rate-cutting cycle. Abrahamsen explains that “the high-yield market generally features floating rates and tends to have a shorter duration than investment-grade bonds, which means that the lower duration is less advantageous as shorter-term rates decline.” This interest rate environment is one reason why spreads in high yield have started to increase, according to Abrahamsen. “Historically, high yield has offered a good yield pickup versus higher quality bonds. But I am less certain that’s the case now.”
“Once you get to high yield, everything is about credit selection. The objective of careful manager selection is to minimize any additional risk you take.”
The investment team at Gard invests in the high-yield market through external managers, focusing on those with a strong track record in credit selection. “Once you get to high yield, everything is about credit selection,” emphasizes Abrahamsen. Given that high-yield investments inherently carry a higher risk profile, “the objective of careful manager selection is to minimize any additional risk you take.”
Private Credit: Illiquid High-Yielding Alternative
Despite having a short duration of liabilities, Gard also maintains a five percent allocation to private credit. “Private credit, which we classify under the alternatives bucket, represents the smallest portion of our fixed-income allocation,” notes Abrahamsen. As an insurer with shorter-duration liabilities, Gard “cannot allocate a significant portion of our fixed-income portfolio to private credit,” explains Abrahamsen. “However, including it as a side pocket to our traditional credit portfolio makes sense. While the underlying fundamentals of both are correlated and influenced by similar economic factors, private credit provides diversification by featuring a distinct set of borrowers.”
He explains that private credit typically falls just below investment grade in the standard credit rating scale, often rated around B or BB, positioning it close to higher-quality high-yield investments. He points out that private credit provides both diversification and a potential yield premium due to its illiquid nature. “Part of the appeal of private assets lies in their perceived lower volatility,” Abrahamsen explains. This is largely because their valuations tend to be less volatile, as they are assessed quarterly. However, he cautions that this does not mean the risk is diminished. “The risk is still present; it’s just located in a different universe. Private credit is a different credit universe compared to the public market.”
“Part of the appeal of private assets lies in their perceived lower volatility. The risk is still present; it’s just located in a different universe. Private credit is a different credit universe compared to the public market.”
Abrahamsen believes there will always be demand for longer-duration assets such as private credit. This asset class has both advantages and disadvantages, with one notable advantage being that the information flow in private markets tends to be superior to that in public markets. “There is no inside information in private markets, so, on average, managers have access to better information than those in public markets, which theoretically reduces risk,” Abrahamsen explains. However, he points out that many borrowers in the private space are backed by private equity firms, creating an incentive for these managers to keep borrowers afloat for as long as possible by restructuring deals, even when default may be the best option. “There are various aspects to private credit; some are good, and others are bad.”
Outlook
While central banks have successfully navigated the challenging task of taming inflation with a soft landing, Abrahamsen raises an important question about what comes next. “We’ve moved beyond the discussion of a soft landing. I don’t think central bankers truly know how to control an economy; they’re doing their best with flawed data. This time, we got lucky,” he reflects. However, he believes it is still premature to declare the death of inflation.
“If that’s the case, then interest rates are likely to rise again, at least in the long run,” Abrahamsen asserts. But he questions how far interest rates can rise before the system starts to strain, noting that “approximately five percent seems to be a limit of some sort.” He further emphasizes his belief that long-term interest rates will continue to rise and remain elevated for an extended period, making government debt particularly unattractive compared to a portfolio of high-grade corporate credit. In the long term, the challenge for central banks lies in “finding an interest rate that balances inflationary pressures within the economy while also enabling governments to finance themselves at reasonable rates. Given debt levels, that seems an impossible task.”
