These Assets are the Best Defense for Market Crashes
Friday, January 21st was a rough day on Wall Street. Concerns regarding interest rate hikes to fight inflation and potential war in Europe led many stocks to plunge. The S&P 500 lost 1.9% that day and continued falling by 2% in the following days. Popular holdings in many portfolios, such as Netflix, Tesla, Disney, and Amazon also felt the pain, losing several percent each. Headlines and experts were predicting the next big market crisis. The good news is that the market slide stopped short of the predicted market crash. The bad news is that one might still be around the corner.
“Winter is here, and the damage under the surface has been enormous and even catastrophic for many individual stocks,” said Michael Wilson, CIO from Morgan Stanley, warning of more trouble brewing as the Fed is expected to raise interest rates. The sentiment was mirrored by other analysts, such as David Kostin, top U.S. equity strategist at Goldman Sachs, who forecasted the S&P 500 might plunge an additional 11% in the coming months.
This is nothing new. Systemic risk means that at any given moment, a bear market is a possibility. The next market crash is inevitable, it’s just a matter of when and how big. But by taking the right decisions ahead of time, its effects can be mitigated. You can, and should, prepare for it by diversifying your portfolio with assets uncorrelated to the main asset classes: bonds and equities.
Diversification is the best defense. Nasdaq recommends it as one of the top ways to protect against a market crash. Choosing what assets significantly contribute to lowering the correlations in the portfolio is difficult, as many are exposed to systemic risk and economic trends. Furthermore, some non-correlated assets have relatively low yields, while others are too volatile.
That’s where insurance-linked assets have the advantage. Thanks to traditional, non-catastrophe insurance perils that are high frequency and low severity in their nature, such as motor liabilities, general liabilities, and more, there are now very attractive alternatives to traditional fixed-income investments sans the systemic risk, and a perfect candidate for portfolio diversification.
Insurance-linked assets are a form of reinsurance - that is to say, insurance for insurance companies, that offer attractive risk-reward in exchange for participating in reinsurance transactions. Investors provide collateral covering the losses of an underlying insurance portfolio, in exchange for reinsurance premiums. The investment opportunity is unique as its performance is not linked to financial markets volatility or economic developments, rather to specific portfolio losses - precisely what is needed for robust diversification.
The vast spectrum of perils that are being securitized is expanding rapidly, offering capital market investors access to new types of insurance-linked assets for the first time. The “high frequency, low severity” nature of these perils means that there are millions, perhaps billions of insurance policies being issued and activated each year in the underlying portfolios. In other words, there are mountains of data over which to create risk projections using AI-based technologies, which are able to accurately predict loss probabilities for stable, predictable returns for investors.
And the reinsurance market is huge - $400 trillion and counting. Only a small percent of which is capitalized. That means there are depths of new investment opportunities waiting for investors. Insurance companies need capital market reinsurance to stay liquid, and as the last shake-up reminds us, investors need reinsurance to diversify.
Up until recently, this whole market was almost completely closed to capital market investors. That is where Vesttoo comes in - our tech-enabled marketplace offers investors direct access to insurance-linked assets. Insurers get direct access to a large source of capital, while investors get stable, predictable yields with attractive risk-reward profiles.
Many experts predict that the US stock market is heading towards a crash akin to that of the dotcom bubble. Whether or not they are right, this is a good reminder that any long-term portfolio must be diversified. With predictable returns that outperform fixed-income investments, Insurance-linked assets are the perfect solution.
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