The world is not only increasingly fraught with geopolitical risk, but increasingly complex in the makeup of its financial system. Ilena Coyle, head of North American insurance and intermediary at Barings, sat down to talk about these issues with Insurance Asset Risk as the company picked up 'structured debt manager of the year' at our awards.
What have been the most-impactful issues on your strategy this year?
We used the size and experience of our Structured Credit Investment and Insurance Solutions teams to create customised client strategies that are designed to meet their risk, return, and regulatory objectives by investing in collateralised loan obligations (CLOs).
We have a 25+ year track record of partnering with our insurance clients to invest in CLO tranches. Over the past year, CLOs have experienced positive performance across the capital structure as elevated interest rates and the potential for incremental yield pickup drew investors to the market. CLO issuance has picked up due in part to the increase in resets and refinancings as CLO managers look to capitalize on strong market conditions.
Our clients benefit from this increased CLO market demand and activity because our breadth of resources, market access, and fundamental bottom-up credit analysis allow us to efficiently evaluate all new issue, refinancing, reset, and secondary market CLO opportunities across the US, European and Private Credit CLOs and deploy capital where we believe the best relative value is.
We spent a large part of this year speaking with investors about opportunities in Private Credit CLOs. Private Credit CLOs (also known as Middle Market CLOs) became a growing part of the CLO market in 2023 and 2024. In 2023, PC CLOs increased to 20% of the new issue CLO market compared to 11% in 20221. Private Credit CLOs offer the potential for further increased spread and credit enhancement levels in exchange for lower liquidity and transparency into the underlying assets. This market presents an interesting opportunity for insurance companies and other buy-and-hold investors who can trade liquidity for yield pickup. We worked with our insurance clients throughout the year to discuss the opportunity and add these investments to their current mandates should they want to invest in the asset class.
We're seeing great geopolitical turmoil against a backdrop in which inflation is starting to cool. How are these two issues impacting your thinking at the moment?
With risks on the horizon ranging from the US presidential election to rising geopolitical tension around the world, we favour constructing up in quality and up in liquidity CLO tranche portfolios. We believe bottom-up credit analysis and careful manager selection will have a crucial impact on investment performance.
Despite the lower inflation rates that have allowed the Fed to begin its rate-cutting cycle, we do not expect to return to the near-zero rate environment of a couple of years ago. With that in mind, we see ongoing demand for floating-rate CLOs because of the attractive spread pickup compared to other fixed-income products.
What is your outlook on assets in the next year?
CLOs are backed by a portfolio of diversified leveraged loans. A lower interest rate environment eases the debt burden on underlying loan issuers and could increase M&A activity. An increase in M&A activity would increase loan volume and create additional diversity and growth within the CLO markets.
On the flip side, macroeconomic factors may cause the underlying loan rate to increase slightly. However, the loan default rate is starting from a low level, and we do not expect them go above historical averages which is well within what CLO structures are built to withstand. These uncertainties underscore the importance of investing with managers with deep credit research teams and experience investing across market cycles.
There's been a trend in recent years where structured debt has been of growing importance to insurers. Where do you expect to see this trend to go?
Insurers are increasingly shifting allocations to select structured debt assets because of their attractive current yields on offer and capital efficiency. CLOs have been the fastest-growing asset class for life insurance companies over the past five years, with allocations increasing to 4.1% in 2023, up from 3.8% in 20222. CLOs offer a floating rate product that provides investors with diversified exposure to actively managed pools of leveraged loans in a structure that has proven historically robust over 30 years. Additionally, CLO's benefit from spread pickup compared to similarly rated corporate assets and add diversity to insurance allocators investment portfolios. Insurance companies have been among the largest investors in AA, A, and BBB-rated tranches, and we expect that trend to continue as the asset class gains increased acceptance. No longer a niche market, the CLO market is over $1 trillion in size, and new players continue to enter this well-performing market sector.
Ilena Coyle, Head of North American Insurance and Intermediary.
