Seventy-six percent now consider the use of alternative investments essential to diversify portfolio risk (76%), according to a new study of 151 U.S.-based institutional investors by Natixis Global Asset Management (NGAM). Seventy-three percent say it is necessary to invest in alternatives in order to outperform the broad market.
The majority (88%) of the respondents who invest in alternative products such as hedge funds, private equity and alternative mutual funds are pleased with the performance of their investments. When asked what they would do if they had to make the choice all over again, 93% say they would increase their allocation to alternatives or invest the same amount; just 7% claim they would decrease their allocation.
The majority (57%) of institutional investors in the U.S. holding alternative assets have done so for eight years or more, with 36% of those reporting they have been investing in alternative strategies for 15 years or more.
One-third (33%) of respondents report that their risk tolerance is lower today than five years ago, compared to 26% who say their risk tolerance is higher. Nearly two-thirds (65%) of U.S. institutional investors agree that reducing risk means accepting lower returns. Approximately one in five (22%) say they cannot effectively manage risk in their portfolio because of unpredictable market volatility.
Three in ten (31%) say their institutions monitor a risk budget daily to keep overall portfolio risk in check; 53% do so on a regular basis (weekly or monthly) and 13% do so occasionally (quarterly or annually). Forty-one percent say their institutions make it a practice every day to consider the volatility of an asset or security before considering its potential return; 42% do so on a regular basis (weekly or monthly) and 15% do so occasionally (quarterly or annually).
The majority (64%) of U.S. institutional investors say traditional diversification and portfolio construction techniques need to be replaced. Seven in ten (72%) say conventional 60/40 portfolios no longer are the best way to pursue returns. Approximately two-thirds believe “increasing allocations to non-correlated assets” (64%) and “increasing the use of liquid alternatives” (68%) are effective strategies for managing portfolio risk. Seven in ten (72%) say the best way to temper market volatility is to increase allocations to non-correlated assets.
A majority (82%) of respondents find it difficult to mitigate the impact of market volatility; 76% report they have had difficulty protecting the portfolios they oversee from dramatic swings in value. Approximately eight in ten (83%) U.S. institutional investors claim it is difficult to meet their total return objectives. More than three in four (78%) say it is difficult to manage tail risk.
Nine in ten (89%) of those surveyed believe volatility creates investment opportunities and 83% say market volatility is here to stay. However, nearly all (97%) institutional investors in the U.S. say their organization does an average or above-average job in constructing portfolios that protect principal and achieve growth; and 91% say their institutions have average or above-average capabilities in constructing portfolios that can generate positive returns regardless of market conditions.
Seven in ten (68%) U.S. institutional investors cite a contagion resulting from Europe’s debt crisis as one of the three most likely sources of market volatility in the next two years. Nearly half (47%) say Europe’s financial woes are one of the top three issues keeping them awake at night, followed by regulatory uncertainty (30%) and discovering unexpected sources of risk in their portfolios (29%).
Asked about the greatest risks to meeting investment objectives, 40% of U.S. institutional investors cited global equity market risk, followed by global fiscal imbalances (36%), geopolitical risk (32%) and changes in tax policies or regulations/laws (30%). Six in ten (60%) say the issue of economic growth has a significant influence on investment decisions, while 50% call the European financial crisis a major influence on their decision-making.
A substantial majority (85%) of U.S. institutional investors believes there will be a tightening of regulatory restrictions on financial institutions and capital markets participants, regardless of the outcome of the U.S. elections. Three in four (74%) believe U.S. financial institutions will have limits placed on their market-making abilities, resulting in their being less competitive.
Asked to select up to three priorities for the next 12 months, 38% say their institution’s number one action will be to use strategies that limit exposure to market volatility. The second-ranked priority, chosen by 33% of U.S. institutional investors, is to pay more attention to actual measures of risk rather than average measures. The third priority (29%) is to increase the allocation to alternative or non-correlated assets.
The online survey of 151 institutional investors in the U.S. was conducted by OnResearch in June and July 2012. Institutional investors surveyed manage or oversee corporate pensions, public/government pensions, funds of funds, sovereign wealth funds, insurance reserves/liabilities, and/or endowments/foundations.
The U.S. study is part of a larger global survey of 482 institutional investors in 13 countries in Europe, Asia and the Middle East, as well as the U.K. A copy of the global survey highlights is available at http://www.ngam.natixis.com/pressroom.