By Alex White - Co-Head of ALM, Gallagher
For example, if everyone is buying the same thing, it may be great or it may be overpriced; and if no-one is buying something it may be useless or it may be good value.
Distressed debt is a great example - no one wants bonds which have already defaulted, but a skilled manager with a bit of patience can often extract a lot of value out of them. It’s often hard to tell whether you’re a brilliant contrarian or a stubborn fool who hasn’t seen what everyone else has.
Sometimes though, assets reach such extremes that you can have a fair degree of confidence. For example, we can compare Investment Grade (IG) credit with insurance linked securities (ILS)[1] in current markets[2].
On the surface, this is not a like-for-like comparison. £1m of ILS is much riskier than £1m of IG credit, and has a meaningful chance of losing all its value. But we don’t need to compare £1m with £1m. Credit returns, at least on a hold to maturity basis, are relatively knowable - you’ll earn the prevailing yield, or the rate plus the spread. Currently spreads are close to historical lows- i.e. credit is about as expensive as it’s ever been, and you might earn about 50-70bps after defaults.
For ILS, this is harder, as you need some sense of how much damage you’ll get from natural disasters. However, the yields are knowable, and are currently at historic highs, with 30% yields achievable[3]. ILS has had some bad years, which spooked investors, and now it’s cheap. That could translate to an expected excess return of 7-8%. That is, if I need to earn the same return as £10m of credit, I can do it with £700k-£1m of ILS and £9-9.3m of cash.
Now the risk profile looks very different. The first portfolio, all in IG, can easily lose 10%; even just a return to more typical spreads on a duration 7 portfolio would be about half of that. The ILS might lose all its value, but the second portfolio would still only lose 7-10% in a worst-case scenario.
Now the typical counter is that credit losses aren’t losses in the same way, because you can simply wait. I’ve written about why this may not be true (e.g. due to unexpected cashflows), but even if we take it as a given, the second investor group could just wait for spreads to widen (knowing that they mean revert too) and buy IG when the price is attractive.
Now most investors should not replace entire IG portfolios with ILS and cash. But they could replace 10% of their IG. And if IG spreads tighten and ILS yields widen, they might do a bit more. A mixture of both also benefits from diversification, not least because hurricanes are rarely caused by financial crashes.
Either way, when markers in fixed income are at sufficiently extreme levels, the contrarian position becomes increasingly attractive. To me at least, the unpopular asset looks much better value right now.
[1] ILS, or insurance linked securities, here refers to catastrophe reinsurance- you earn the yield unless specific insurance losses, typically from US hurricanes, go above a certain threshold, where you start covering the losses- so you mostly make a decent return, but with very large tail risk
[2] mid Jan 2026
[3] The market is fairly complex and negotiated, which means as yields widen investors are also often getting more favourable legal terms, as they’re generally negotiating from a stronger position when they’re a more scarce resource
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