While the market volatility may be surprising to some, institutional investors have been diligently diversifying their portfolios in anticipation of its return, Natixis Investment Managers found in a survey of 500 institutional investors around the world.
Seventy percent said that adding alternative investments to a portfolio is important for diversifying risk. Natixis then asked them to match various alternative strategies with specific portfolio objectives. For diversification, institutional investors most commonly cite global macro strategies (47%), commodities (41%) and infrastructure (40%).
As interest rates rise and the 30-year bond bull market ends, to replace fixed income, institutional investors point to infrastructure (55%) and private debt (47%).
To help mitigate volatility, these investors are turning to managed futures (46%) and hedged equity (45%). To generate alpha, they cite private equity (72%) and hedged equity (45%). As a hedge against inflation, they view commodities (56%) and real estate (46%) as the best strategies.
Seventy-six percent of institutional investors think the current market favors active managers. While they acknowledge that alternative investments can present a range of portfolio risks, 74% say the potential returns of illiquid investments are worth the risk. Sixty-six percent think that solvency and liquidity requirements have created a strong bias for shorter time horizons and highly liquid assets.
Natixis also discovered that many institutional investors are embracing environmental, social and governance (ESG) investing, and among those that are, their top reason, cited by 47%, is to align their investment strategy with organizational values.
Sixty-one percent of respondents expect ESG investing will become a standard practice within the next five years, 59% say there is alpha to be found in ESG investing, 56% believe it mitigates risks, and 29% say ESG investing can generate high risk-adjusted returns over the long term. Overall, institutional investors believe that these strategies will help them deliver average returns of 7.2% this year.
Given that institutional investors are facing a variety of market risks, including interest rates, volatility and geopolitics, 63% of institutions say it is a challenge for their organization to gain a consolidated view of risks across their portfolio. To help mitigate risk, 84% say diversification is key. Eighty-one percent say risk budgeting is an effective tool, and 46% say integration of material ESG factors is useful in controlling portfolio risk.
Asked about long-term risk concerns, longevity risk was cited by 78% of corporate pension plans, 76% of public pension plans and 85% of insurance firms.
Forty-four percent of institutional investors outsource at least some portion of their investment management function. Among those that do, they outsource management for 41% of their portfolio. As to why they outsource, 49% say it is to access specialist capabilities. Seventeen percent say they will consider outsourcing investment decision making in the next 12 months, up from 13% who said the same in 2016.
“The sudden return of market volatility is a healthy reminder that it’s important to take a consistent approach to portfolio diversification,” says David Giunta, chief executive officer for the U.S. and Canada at Natixis Investment Managers. “Institutional investors are increasingly turning to active managers and alternatives for the tools and flexibility to diversify their portfolios and mitigate risk.”