Institutional investors warn of increasing correlations, finds Natixis survey

Institutional investors worldwide say it is challenging to find diversification among traditional asset classes, with more than half (54%) saying stocks and bonds are too highly correlated to provide distinctive sources of return, according to a recent survey by Natixis Global Asset Management. The survey also found evidence that alternative assets are taking on new prominence within institutional portfolios to help generate better risk-adjusted returns - the top priority of institutional investors in 2016.

“In the current market, traditional asset allocation has become a zero-sum game,” said John Hailer, Head of international distribution and chief executive officer of Natixis Global Asset Management Americas and Asia. “An investment approach that’s fit for modern markets is needed. Institutional investors are increasingly moving to a broader mix of non-correlated assets alongside traditional stocks and bonds.”

Two-thirds (66%) of institutional investors believe that an effective way of easing risk is to increase allocations to non-correlated assets, including private equity, private debt and hedge funds. Nearly half (49%) say it is essential to invest in alternatives in order to outperform the broader markets.

The Natixis survey of 660 institutional investors includes corporate, public and government pension funds, sovereign wealth funds, insurance companies, and endowments and foundations collectively managing more than $35 trillion in assets.

Institutions worry about their ability to fund liabilities in a volatile, low-rate market. In response, they are adapting their investment strategies, risk management approach and business operations to better meet their long- and short-term obligations.

Eighty-four percent of institutions say the low-yield investing environment is their biggest concern for managing risk, followed by generating returns (82%) and funding long-term liabilities (72%). Nearly seven in ten (68%) say meeting growth objectives and short-term liquidity needs are a challenge to their organization.

“These findings illustrate the dilemma faced by institutional investors, who are forced to call into question their traditional portfolio management techniques in order to respond to the challenges of an increasingly complex and turbulent  financial environment”, explains Christophe Point, Head of Natixis Global AM Distribution for France, French-speaking Switzerland and Monaco. “They are aware that they have to review their portfolio construction approach to maximise diversification and reduce risk”.

Performance expectations in an active / passive world

While costs are top of mind for institutions and many will increase usage of passive strategies in more efficient asset classes, active strategies still hold favor for pursuing better returns overall. Currently, 64% of institutional assets are managed actively and 36% are managed passively. Fifty-eight percent of investors say that, over the long term, active investments outperform passive ones. And, in the next 12 months, 67% say economic factors, changing monetary policies and market volatility will favor active managers.

The majority of institutional investors agree that active management is a source of alpha (87%), accessing non-correlated asset classes (77%) and taking advantage of short-term market movements (71%).

“Concerned by the increase of correlation between asset classes and underlying risks - particularly in an uncertain market context - a growing number of institutional investors are seeking truly active fund managers, to deliver performance decorrelated from financial market volatility”, adds Christophe Point. “They are increasingly moving towards a broader mix of active and passive investment management strategies in their portfolios, aware of their respective advantages.”

Rising need for LDI innovation
The vast majority of institutions are concerned over meeting their long-term objectives and are looking for more innovative LDI (liability-driven investing) solutions.

72% of institutions say they are concerned about their ability to fund long-term liabilities, and 68% say it is a challenge to manage uncertain liabilities linked to increased longevity. Although nearly three-quarters of institutions (73%) say they have tools to manage liability assets, 78% say they are looking for more innovative LDI solutions for today’s markets, a significant rise from 60% in 2014.

“As the population ages and people live longer, underestimating future liabilities is a significant risk for institutional investors,” Hailer said. “Institutions are expressing growing demand for product improvements to better manage long-term liabilities. The findings of our survey continue to suggest that LDI innovation is not keeping up with the demands of institutional investors.”

Incorporating ESG investing

Many institutional investors (64%) say it has become increasingly difficult to achieve alpha. Half now see environmental, social and governance (ESG) investments as a potential source of return, and 51% say ESG assessments help mitigate headline-making risks. Most (95%) institutional investors are to some extent incorporating environmental, social and governance (ESG) strategies. More than four in ten (41%) of them do so, primarily because it’s in their fund’s mandate.