Institutional investors are set to make bigger bets on riskier assets during 2017 in pursuit of higher returns, according to a new report.
“Faced with greater volatility and continued rate pressures, [institutional investors] appear to be doubling down on their bets by increasing allocations to equities, private equities, and other high-risk assets seeking to generate returns,” says the report from Natixis, the global asset management firm.
The report surveyed 500 decision-makers at global tax-exempt institutional funds holding the purse strings for assets earmarked for pension payouts, insurance settlements and funding for endowments, representing $15.5 trillion.
Despite a market environment buffeted by political, geopolitical and regulatory uncertainty, 70 percent of those surveyed believe their return expectations for 2017 are achievable. However, 75 percent of respondents believe investors “might be taking on too much risk in pursuit of yield,” according to Natixis.
“Faced with prospects of increased volatility, six in ten institutional decision makers believe they are prepared to handle the risks in 2017,” the report says, “but given the economic complexities, coupled with ongoing political upheaval, only 2% offer up strong convictions in their ability to succeed in this critical endeavor.”
Market volatility poses the biggest risk to portfolio performance, institutional managers said, with 62 percent saying they were confident in their ability to manage such risk. The top organizational concern, however, is low yield. Given the uncertain investing climate surrounding today’s global markets, “few institutions are relying on traditional portfolio strategies to meet their performance goals,” Natixis said. “Instead they are increasing their exposure to equities and alternatives and turning to illiquid assets and the private markets for risk-managed return generation and yield replacement.”
The top challenge for these organizations in 2017 looks to be balancing growth objectives with short-term liquidity needs, according to 60 percent of respondents. The second-ranked challenge is gaining a consolidated view of portfolio risk (46 percent), followed by complying with new regulations (39 percent).
“While risk factors change over time, the challenge for institutional investors remains to deliver long-term results while navigating short-term market pressures,” said David Giunta, Natixis’ president and CEO for the U.S. and Canada, in a statement. “Given their mandates, avoiding risk is not an option for institutional investors,” Giunta said. “They have to beat the odds or change the game, and they are doing so by balancing risks and embracing alternatives to traditional 60/40 portfolio construction, but always with an eye on their long-term objectives.”
Half of the respondents cited market volatility as the biggest risk to performance in 2017, which was followed by geopolitical risk (43 percent) and interest rates (38 percent).
Most respondents said they were confident of their ability to meet their long-term liabilities; however, they weren’t all that confident in their peers. Some 62 percent think most institutional investors will fail to meet those commitments. Sixty-nine percent agree that “traditional diversification and portfolio construction techniques need to be replaced with new approaches,” Natixis said.
Managing risk is a pressure that “cannot be underestimated,” the report says. And in doing so, managers are “hedging their bets,” the report says. Nearly 70 percent of institutional managers surveyed said they “are willing to underperform their peers to ensure downside protection,” the report says, noting that just 54 percent of respondents believe that portfolio diversification “can provide adequate downside protection.”
Other findings in the survey include:
- Sixty-seven percent of institutional investors think private equity provides higher risk-adjusted returns than traditional asset classes, and more than half (55%) believe private equity provides better diversification than traditional stocks. The three areas they consider most promising are infrastructure, healthcare and the technology, media & telecom sector.
- About one-third (34 percent) of institutions report that they are planning to increase allocations to real assets, including real estate, infrastructure and aircraft financing, in the next 12 months. As seen with their broader views on private markets, 63% of institutional decision makers’ primary goal for investing in real assets is earning higher returns.
- Half of institutions (50%) report they are increasing exposures to alternative investment strategies this year. The adoption of alternative investments isn’t limited to growth portfolios, as 77% of respondents say alternatives have a role in liability-driven investing as well.
By seeking to meet risk/return objectives, decision-makers are going outside their own team to tap into specialized capabilities. Four out of ten institutions (42 percent) are outsourcing CIO and/or fiduciary manager tasks. “On average those organizations that outsource have turned over management for 37% of their total portfolio,” Natixis said.