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The importance of asset allocation and portfolio construction cannot be overstated in today’s investment environment, where geopolitical tensions and a changing interest rate regime bring about increased market volatility. While diversification has long provided resilience to multi-asst portfolios, institutional investors and insurers in particular might need to adopt a more agile and granular approach because return outcomes are highly unpredictable. There are challenges in front of us – but numerous growth opportunities as well.

Although the looming tariffs from the new US administration pose a serious macroeconomic test, they are unlikely to significantly damage overall global growth. We expect a soft landing for the world economy, but levies will impact different countries in varying degrees, with China, Mexico and Canada possibly bearing the brunt. The US itself is not immune; as the new policy agenda takes shape, measures such as tariffs could spur domestic inflation, raising the risk of the economy overheating.

Against this macro backdrop, our asset class preference leans toward global equities, while fixed income remains attractive in risk-adjusted terms. Nevertheless, since return expectations for equities over the next few years are slightly lower than in the past, insurers are increasingly seeking alternative sources of income that comply with regulatory and solvency requirements – a task that is far from simple.

To start, investors could consider enhancing the relatively low equity levels in insurance portfolios. There are still opportunities in the US market with more reasonable valuations and robust earnings growth beyond the top tech giants known as the Magnificent Seven. In addition, our positive equity outlook extends beyond US stocks as global growth remains resilient.

Fixed income has traditionally been a cornerstone of insurance portfolios, but it has experienced volatility in recent years. This year, we anticipate interest rates to decline further, though the pace is likely to vary from country to country. We do not foresee a significant shift in the downward inflation trend, which should permit additional rate cuts while keeping rates at a relatively elevated level, thereby bolstering fixed income returns in 2025. We view emerging-market debt and high-yield bonds as particularly attractive options.

Outside of traditional asset classes, alternatives are becoming increasingly important for insurers, especially when equities fail to provide sufficient income. Although private markets have struggled with higher interest rates in recent years, we expect a recovery in the real estate sector (excluding offices), which seems to be nearing its lowest point. Furthermore, private infrastructure and credit offer more attractive opportunities compared to their listed and public counterparts.

In addition to macro and market challenges, most global insurers are limited by regulatory mandates that lead to an overweight in domestic and traditional assets, and China is no exception. Recent surveys show that fixed income allocation has increased to over 60%, whereas public and private equity allocations are declining, along with a shift away from real estate and commodity-related assets.

Because of their home bias, Chinese insurers are particularly affected by domestic economic and market issues. These include a sluggish property market, deflationary risks, currency pressure, regulatory constraints, and perhaps most challenging, an extended low interest rate environment. Potential outcomes for Chinese insurance portfolios include lower returns on fixed income, higher reinvestment risk, increased liabilities and solvency pressure.

History provides valuable insights into how other insurance companies have managed prolonged periods of low interest rates. Japanese insurers after the burst of the country’s asset price bubble and European insurers after the Global Financial Crisis took strong measures to diversity and better manage their liabilities. They increased their allocation to alternative assets, sought higher yields abroad, and even reduced or eliminated industry-wide guaranteed yields. These lessons can be valuable for Chinese insurers, and indeed, many are already moving in this direction.

Diversification enhances the resilience of an insurance portfolio, but it should not stop at the asset class level. It is not as simple as equity versus fixed income, risk-on or risk-off; it is about determining where within an asset class you want to assume risk. Predicting return outcomes is difficult, so insurance investors should look for diversification at a more detailed and granular level.

Consider a portfolio focused on China or Asia as an example. Over the past year and a half, Asia high yield has presented attractive value following a protracted downturn in China high yield. Although the global market has moved on, our analysis indicates that Asia high yield continues to provide strong diversification benefits due to its low correlation with other asset classes. Additionally, the default rate is at a historic low, even lower than in the US and Europe.

On the equity side, we also like high dividend stocks in a few Asian markets, particularly in China. Against a deflationary macro backdrop, high dividend stocks offer defensiveness and a stable return stream in our view. For a China or Asia oriented portfolio, insurers could consider a barbell approach with focus on high dividend stocks on one hand and tech stocks on the other. And we see opportunities in Chinese tech especially on the back of the DeepSeek phenomenon.

When looking at alternatives, gold could be a useful diversifier. We also focus on liquid alternatives such as Asian and European REITs as well as listed infrastructure and hedge funds. Nevertheless, while private credit offers opportunities, it can sometimes behave like equities, so investors should proceed with caution.

Being agile and flexible is equally crucial. Markets are fast-moving and rallies are often short-lived, especially in China and Asia. Insurers need to be prepared to act swiftly. A more evolved approach will enable insurers to identify and take advantage of growth opportunities in this volatile environment.