Investors’ Appetite for Gains Exceeds Their Stomach for Risk, and Index Funds May Not Deliver What They Want

More than two-thirds of global investors feel financially secure, emboldened enough by strong market gains to take additional investment risks. But the record highs and historic calm over the past year aren’t enough to soothe their fear of losses. Investors’ definition of risk seems to be focused on the loss of capital and not on investment opportunities.

Natixis’ survey also shines a light on investors’ confusion over even basic topics, such as the attributes of index investing, pointing to a need for greater clarity. Although 72% of French investors continue to say they would prefer safety over performance, they also say they need returns of 9.1% above inflation. At a time when many market experts are forecasting low single-digit returns over the long-term, investors may need to rethink their strategy and turn to truly active managers that strive to outperform market benchmarks through superior security selection.

Skeptical and confused, French investors value advice more than ever

The majority (72%) of investors say the asset management industry provides value for money, but they need to be reassured that those firms are managing their assets in their best interests. Some of this skepticism can be traced to closet indexers – firms that claim to actively manage their funds and charge commensurate fees, but deliver portfolios that mimic benchmarks. Sixty-two percent of French investors say they expect their mutual funds to have portfolios that differ substantially from their benchmarks, but two-thirds (66%) believe many managers charge active fees while really just tracking an index. In Natixis surveys last year*, 57% of institutional managers and 43% of financial advisors cited the prevalence of closet indexers as a reason they used passive strategies.

The survey also found continued misperceptions about index investments. Fifty two percent of investors mistakenly believe index funds are less risky and 60% say they help minimise losses, even though index funds track both the ups and downs of the markets they follow and provide no built-in risk management. Seventy-five percent of global institutions* said investors have a “false sense of security” about passive investing. Asked to compare the relative strengths of active and passive investments, 86% of institutional investors say active is better suited to generating alpha, to generating risk-adjusted returns (64%), for accessing emerging market opportunities (76%), and for ESG investing (75%), while passive investment management is regarded above all as a way to reduce management fees.

These differences in perception reflect the challenges that individual investors are facing. The good news is that investors are ultimately seeking out the assistance of financial advisors: 66% of French investors receive financial advice and 65% of them believe they need an expert to find the best investment opportunities (65%).

“Through our research, investors tell us loud and clear they need advice, they’re confused about passive investing, and they want transparency and value for their money,” said Jean-François Baralon, Head of Natixis Global Asset Management Distribution for France, French-speaking

Switzerland and Monaco. “Individual investors tend to attribute to index funds advantages that they

don’t always have in terms of risk control. Truly active management, on the other hand, can help to optimise risk and generate alpha over the long term.”

ESG demand from individual investors grows, but may not be compatible with passive index investing

Almost 80% of French investors say they want their investments to reflect their personal values and adhere to high standards for environmental, social and governance (ESG) criteria. Seventy-two percent say it is important to invest in companies that are ethically run, while 67% believe it is important to invest in companies that have a positive social or environmental impact.

But the desire for investments to better match personal convictions is difficult to rationalize for investors who rely solely on traditional passive index funds, as hundreds of companies are included in many popular indexes regardless of their corporate behavior or ethics. Only 44% of French investors say index funds contain companies that reflect their personal values.

Investors are looking for alternatives, but need help

French retail investors express a great need to integrate risk management into their investments. Seventy-six percent seek investment solutions that provide them with greater diversification, a better risk/reward pairing (78%), protection from volatility (75%) and decorrelated performance (74%). Yet, while alternative investments could help meet these needs, only 40% of French individual investors say they invest in them.

“The financial industry as a whole has an important role to play to help investors make thoughtful long-term investment decisions and to enable them to explore all the investment strategies available. It is encouraging to see that investors are showing a greater interest in ESG and alternative solutions, but to best utilise these strategies, investors need education, clarity and professional advice,” concludes Jean-François Baralon.

*2016 Natixis Institutional Investors Survey released in March 2017. Carried out in October and November 2016 among 500 global institutional investors