Institutional investors worldwide say it is challenging to find diversification among traditional asset classes, with more than half (54 per cent) saying stocks and bonds are too highly correlated to provide distinctive sources of return.
That’s according to a recent survey by Natixis Global Asset Management, which also finds evidence that alternative assets are taking on new prominence within institutional portfolios to help generate better risk-adjusted returns – the top priority of institutional investors in 2016.
“In the current market, traditional asset allocation has become a zero-sum game,” says John Hailer, chief executive officer of in the Americas and Asia and Head of Global Distribution at Natixis Global Asset Management. “An investment approach that’s fit for modern markets is needed. Institutional investors are increasingly moving to a broader mix of non-correlated assets alongside traditional stocks and bonds.”
Two-thirds (66 per cent) of institutional investors believe that an effective way of easing risk is to increase allocations to non-correlated assets, including private equity, private debt and hedge funds. Nearly half (49 per cent) say it is essential to invest in alternatives in order to outperform the broader markets.
The Natixis survey of 660 institutional investors (including 90 from the UK) includes corporate, public and government pension funds, sovereign wealth funds, insurance companies, and endowments and foundations collectively managing more than $35 trillion in assets.
Institutions worry about their ability to fund liabilities in a volatile, low-rate market - managing volatility in investment returns was the greatest concern of investors from the UK (selected by 54 per cent of respondents). In response, they are adapting their investment strategies, risk management approach and business operations to better meet their long- and short-term obligations.
Eighty-four percent of institutions say the low-yield investing environment is their biggest concern for managing risk, followed by generating returns (82 per cent) and funding long-term liabilities (72 per cent). Nearly seven in ten (68 per cent) say meeting growth objectives and short-term liquidity needs are a challenge to their organisation.
While costs are top of mind for institutions and many will increase usage of passive strategies in more efficient asset classes, active strategies still hold favour for pursuing better returns overall. Currently, 64 per cent of institutional assets are managed actively and 36 per cent are managed passively. Fifty-eight percent of investors say that, over the long term, active investments outperform passive ones. And, in the next 12 months, 67 per cent say economic factors, changing monetary policies and market volatility will favour active managers.
The majority of institutional investors agree that active management is a source of alpha (87 per cent), accessing non-correlated asset classes (77 per cent) and taking advantage of short-term market movements (71 per cent).
“The anemic returns being generated by traditional approaches to the mainstream asset classes show that it is crucial investors look for more innovative solutions,” says Euan MacLaren, Head of UK and Ireland Institutional Business at Natixis Global Asset Management. “While investors are increasingly allocating towards alternatives as a means to improve diversification and boost performance, it is also important to make smarter use of stocks and bonds, and a genuinely active management approach is one of the best ways to achieve this.”
The vast majority of institutions are concerned over meeting their long-term objectives and are looking for more innovative LDI (liability-driven investing) solutions.
Some 72 per cent of institutions say they are concerned about their ability to fund long-term liabilities, and 68 per cent say it is a challenge to manage uncertain liabilities linked to increased longevity. Although nearly three-quarters of institutions (73 per cent) say they have tools to manage liability assets, 78 per cent say they are looking for more innovative LDI solutions for today’s markets, a significant rise from 60 per cent in 2014.
“As the population ages and people live longer, underestimating future liabilities is a significant risk for institutional investors,” Hailer says. “Institutions are expressing growing demand for product improvements to better manage long-term liabilities. The findings of our survey continue to suggest that LDI innovation is not keeping up with the demands of institutional investors.”