Cerulli Reports Investor Moves Away from ‘Pure Beta’

Duration-focused equity and fixed-income exposures have long formed the basis of large institutional portfolios not tied to the future income needs of a single individual or family, but today’s forward-looking institutions are seeking more than “pure beta.”

“Beta” is one of those terms that gets thrown around a lot by investing industry professionals (and their clients) without a whole lot of clarity as to what is actually meant.

Advisers will know that the basic term arises from modern portfolio theory, which speaks of the “beta coefficient” of an investment portfolio to indicate whether the investment is more or less volatile than the market from which it is drawn. In general, a beta value below one indicates that the investment portfolio can be expected to be less volatile than the market as prices fluctuate, while a beta of more than one indicates the opposite.

In the first quarter 2016 issue of “The Cerulli Edge, U.S. Institutional Edition,” the financial research and analytics firm finds institutions of all stripes are actively considering the implications of volatility and constrained liquidity on their long-term goals—and they are beginning to rebalance portfolios accordingly. As part of this rebalancing, institutions are increasingly willing to consider alternative conceptions of measuring and using a portfolio’s “beta.”  

At a very high level this reflects institutional investors’ concerns with the topline health of global markets, Cerulli explains. Institutions are clearly listening to their investment managers and advisers, who are warning that winners and losers are reemerging in markets after years of nearly universally strong performance across economies, sectors, geographies, etc.

“While some are acting based on pressures outside of those in the financial markets, most are drawing lessons from the major losses experienced in 2007-2008 and taking precautions after years of post-financial-crisis gains,” explains Alexi Maravel, director at Cerulli.

NEXT: How this applies to retirement plans

Probably the most relevant aspects of beta for the retirement plan domain come up in the perennial active-versus-passive investment option debate.

Retirement plan officials, it seems, constantly face the question of which is a better option for retirement plan investors. Under modern portfolio theory, passive investments are purchased under the conviction that having a “pure beta exposure” to the market—i.e., a beta of exactly one—will serve investors best, mainly because it is so hard to consistently predict the performance of any given stock or holding in the index. One might as well hold everything, gaining all the upside at the price of being exposed to all the downside.

These days institutional investors are essentially balking at that assessment, Cerulli says, despite the fact that pursuing pure beta had served them well as recently as 2014. As Maravel observes, equity markets disappointed in 2015 and “are already struggling in 2016 with the worst start to a calendar year in a decade.” Beyond this, interest rate uncertainty still abounds, leading institutions to consider the opposite conviction under portfolio theory—that one might as well use all the data and intelligence one has access to in order to tilt one’s beta exposure towards the parts of the market that are likelier to grow looking forward, given current conditions.

As such, Cerulli finds many types of institutional investors are interested in strategies in which an investor “can capture returns with low or no correlation to their other investments, such as absolute return, alternative credit, or infrastructure strategies, all of which tend to be actively managed … Conversations with both institutions and asset managers seem to begin and end with concerns about corporate spread widening and bond market liquidity.”

NEXT: A few more conclusions 

Maravel adds that, beneath the headlines, there are “numerous indications of a change in the 'risk-on' approach that has benefited so many investors.”

"Institutions are increasing their awareness of the vulnerability to risk and volatility and it's pushing institutions to re-allocate away from the passive index investments—pure market beta exposure—they have favored in the past six or seven years," Maravel continues.

Rather than going strictly “risk-off,” Cerulli believes that investors will try to go more “risk-selective.” In the retirement space this will play out with continued vigorous growth around liability-driven investing (LDI) programs and products.  

“Cerulli believes that growth in the LDI market will come to pass, though the road will not be a straight line, owing to bond market technical factors, liquidity, and residual corporate resistance to adopting liability-hedging strategies with long-duration fixed income,” Maravel concludes. “Cerulli recommends that managers invest in their fixed-income and derivatives capabilities, and in non-investment resources such as actuarial experts. Managers should prepare not only for growth in LDI client assets, but also for clients’ need for advice on all de-risking options as funded status improves.”

Cerulli’s research also concludes that LDI strategies are “slowly moving beyond long-duration fixed income to include more multi-asset-class solutions, especially on the return-seeking side of the client’s portfolio, with the integration of equity managed volatility strategies.”

These findings and more are found in the first quarter 2016 issue of The Cerulli Edge - U.S. Institutional Edition dedicated to rebalancing. The issue explores managing volatility and liquidity concerns, and liability-driven investments.