Data & Research July 19, 2016

Investors Miss Much of the Subtlety in ‘Active vs Passive’

Findings from a Natixis survey suggest many investors have expectations that “don’t reflect a full understanding of the risks of index funds versus the benefits.”
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More than three-quarters of investors agree that index funds and exchange-traded funds (ETFs) are usually a cheaper way to invest compared with active equity mutual funds, but 71% “also believe they are less risky,” according to new research from Natixis Global Asset Management.

According to Natixis, 64% of investors “think using index funds will help minimize investment losses,” despite the fact that the simple category title of “index fund” says next to nothing about the actual risk characteristics of the investment being considered. Similarly, nearly seven in 10 (69%) investors “believe index funds offer better diversification,” and nearly the same number (61%) believe index funds “provide access to the best investment opportunities in the market.”

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Natixis finds many investors expecting lower risk via indexed investments “were surprised at the start of 2016 when the Standard & Poor’s 500 had its worst opening since 1928.” The index bottomed out on February 11, having fallen 10.5% since trading began in January, Natixis explains. “The market did rebound, finishing the quarter 0.7% ahead, but tracking the index would have resulted in a hair-raising ride. And while the first quarter might be seen as an anomaly, volatility in markets is not.”

Taking this all together, Natixis urges financial services providers to ensure their clients understand up front what the real definitive characteristics of “active versus passive” actually are.

“It is critical to understand the risks in your portfolio, so it’s troubling to see investors mistakenly assign benefits to index funds that they don’t actually have,” adds John Hailer, CEO of Natixis Global Asset Management for the Americas and Asia. “Index funds have a place in portfolios, but their low cost seems to be providing a ‘halo effect’ that could blind-side investors during volatile markets. Professional investors see the role for passive investing differently.”

NEXT: Open to new strategies and approaches 

According to Natixis, the survey finds evidence that investors are willing to move beyond 60/40 allocation investment approaches.

“Nearly two-thirds (65%) say a traditional approach (equities and bonds) to portfolio allocation is no longer the best way to pursue returns and manage investments,” the research finds. “Further, 70% of investors want new strategies that are less tied to broad markets and 75% favor strategies that can help them better diversify their portfolio, an approach that would seem to open the door to wider ownership of alternative investments.”

While just over half of investors (52%) surveyed actually own alternative assets—a grouping that includes private equity, long-short funds, hedge funds and real estate—investors who don’t own alternatives say the assets are too risky (56%). Another 34% in this group “acknowledge they don’t understand how alternatives work,” and 28% “don’t think they need alternatives.”

Natixis finds investors say learning more about investing is the number one thing that would help them better achieve their investment objectives. Overall, 68% of investors surveyed by Natixis “avail themselves of some type of advice, with 48% working exclusively with personal financial advisers and 6% using “only automated online services.” Another 14% use a combination of personal and robo-advisers.

“It is encouraging to see investors are looking beyond traditional asset classes to build portfolios designed to help them reach their financial goals through the widest range of potential market conditions,” Hailer concludes. “However, it is clear the financial industry still needs to provide more education to help investors make informed decisions.”

Additional survey findings are presented here. 

The Markets July 19, 2016

Understanding of ‘Material’ Shifting in ESG Space

Research from global analytics firm Cerulli Associates finds that institutional investors in general no longer limit review of their assets to traditional financial metrics such as revenue, profitability, or valuation.
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There is an increasing amount of evidence to show environmental, social, and governance (ESG) practices of publically traded companies correlate directly with other astute business procedures—supporting positive financial performance.

According to Cerulli’s third quarter 2016 issue of The Cerulli Edge – U.S. Institutional Edition, a growing percentage of asset managers proactively consider ESG factors in conjunction with traditional financial analysis to identify risks and opportunity when investing in companies and evaluating their business practices.

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Although many asset management firms have adopted ESG principles, “determining how to implement them remains a work in progress,” warns Michele Giuditta, associate director at Cerulli. “More than half of consultants polled by Cerulli have dedicated resources for ESG manager research, and others are considering adding resources. Cerulli urges asset managers who are not taking ESG criteria into consideration to re-evaluate this decision.”

In addition to their own interest in boosting investment performance, investor demand is another top reason why investment managers are taking ESG issues into consideration, Cerulli finds.

“Investors no longer limit review of their assets to metrics such as revenue, profitability, or valuation,” the report explains. “Strong ESG can correlate with astute business practices and positive financial performance. The financial crisis of 2008 and several cases of management misconduct have prompted institutional investors to conduct deeper operational due diligence before allocating to hedge funds, for example.”

According to Cerulli, some of the ESG considerations that U.S. institutional investors increasingly consider include “political contributions, executive compensation, air and water pollution, deforestation, labor standards, human rights, and many others.” The vast majority (88%) of asset managers integrate at least some of these “ESG risks and opportunities” into their general financial analysis. “However, they vary in how comprehensively they conduct their research,” Cerulli warns.

NEXT: What sound ESG practices look like 

Given that sound ESG practices can add value to portfolio companies and mitigate risks, Cerulli believes that the longer-term benefits will generally outweigh the costs of ESG due diligence.

“Investor demand is already the top reason why alternative investment managers take ESG issues into consideration, with 75% citing this as a motivation,” the report continues. “The objective of an effective operational due diligence process is to identify, and then mitigate to the best extent possible, operational risks that could lead to material losses for investors.”

Some institutional investors are asking increasingly specific and directed questions of the asset managers themselves during due diligence investigations into new providers, for example questioning how well the asset managers’ employees are trained and policed on compliance policies or data security. 

“These factors should not be overlooked,” Cerulli concludes. “A thorough manual is useless if a hedge fund’s employees do not bother reading it. Using more well-known and highly regarded third-party providers can help speed the process and alleviate business concerns, especially for smaller [investment providers].”

Additional findings and more information on obtaining Cerulli reporting is here. 

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