By James Williams – Institutional investors, from public and private pension plans to foundations, endowments and sovereign wealth funds, are showing significant signs of divergence when it comes to asset allocation; a markedly different story from previous years when the set allocations made from one plan sponsor to another were largely consistent.
eVestment, the leading data, analytics and market intelligence provider to the institutional investment community, is well placed to shine a light on how asset allocation trends are changing in the market.
“What we see is that certain corporate pension plans are going one way and significantly de-risking and moving into liability-driven investments whereas other plans are doing the complete opposite. In fact, public pension plans are moving further up the risk spectrum to try and earn their way out of some of the funding gaps created by the financial crisis five years ago,” explains Ben Olmstead (pictured), Vice President of New Product Innovation at eVestment.
Before expanding on how these investment habits are changing it should be noted that the overall trend that remains prominent is one of de-risking. Institutions have been buffeted by significant volatility in equity markets in recent years and although equity markets have rebounded in 2013, caution remains. But this is not to suggest that institutions are playing too safe; for example, with respect to fixed income, plans appear to be moving more into debt products with increased yields such high yield bonds, corporate bonds, global multi-sector fixed income.
Actively-managed US equities have witnessed USD1.05tn of asset outflows over the last eight years, by contrast traditional debt strategies have attracted over USD1tn in net assets. A lot of this has been driven by the LDI investing trend prevalent in US corporate plans.
“There’s a general pivot away from standard US core fixed income and a pivot into fixed income with increased yield. Plans are replacing some of their equity investments with emerging market debt, high yield debt and global multi-sector products,” confirms Olmstead.
European institutions have approached their allocation exercise differently from US and Asian institutions due to the more pronounced slowdown in Europe. This has manifested in European institutions shunning sovereign debt globally for the last few years. Only recently has that trend begun to reverse.
Anti-home court bias and global instruments
In the US, institutions have been diversifying their way out of trouble by looking beyond their domestic markets, says Olmstead. Post-crisis, the fear and uncertainty of economic recovery drove investors to reduce their allocations to US equities (primarily large-cap equities) and debt and rotate into other geographies.
“We saw a lot of assets leave the US and get invested in emerging market debt, global equities etc. The mindset of investors was ‘The grass has to be greener elsewhere,’ and this drove the anti-home bias,” explains Olmstead.
While US institutions were selling US debt and equities and UK plans were doing likewise, Asian investors were doing the exact opposite. For them, it was all about investing in their own domestic markets; an interesting sub-plot to the anti-home bias trend in the West and bucking the overall global de-risking trend.
Between March 2006 and March 2013 cumulative asset flows among Asia ex-Japan investors have increased to over USD60bn for fixed income and over USD30bn for equities.
Moreover, Asian institutions appear to be first-movers compared to other global institutions, at least over the last couple of years. “At the end of last year, for example, Asian plans started selling emerging market equities and debt while this year they have started buying US equities,” says Olmstead. “The rest of the market only started moving to the sell side in mid-2013 so in that respect Asian investors were six months ahead of the curve.”
The major shift that took place post-crisis from equities to fixed income continues to take place as part of the overall global de-risking trend. Moreover, that theme is one of rotation out of country-specific strategies into more multi-regional strategies.
Between 2010 and Q3 2013, for example, Canadian equity experienced outflows of USD7.5bn, US equity recorded outflows of USD333bn and the UK recorded outflows of USD45.9bn. In sharp contrast, global equity recorded net inflows of USD78.9bn while emerging market equity attracted USD226.5bn.
The point here is that in wildly fluctuating markets, the investment committees of pension plans are less equipped to move quickly to adapt to market changes. Better instead to hand the reins to active managers running global mandates. For a US institution this makes perfect sense as they still maintain some degree of exposure to US equities, as a global equity mandate will still have significant coverage of US markets.
This same trend away from country-specific strategies into more broad-based strategies is also being seen in fixed income as investors diversify away from country specific debt into global multi-sector debt strategies. There is also an emerging trend of plans moving from emerging markets debt into global debt categories.
“A global multi-sector debt mandate allows the manager to invest in many more places than just emerging markets even though these mandates hold an average 18.3% allocation to emerging markets.
“When the markets are highly volatile, investment committees find it difficult deciding how much they should allocate to each region. It makes sense to allocate to a global allocation bucket where the investment manager can adjust the strategy accordingly. Global multi-sector managers are better placed to increase exposure to emerging market debt if needed, or a lesser amount if needed, based on what they are seeing in the markets,” comments Olmstead.
US investor trends – EM equities reducing, floating rate loans rising
Olmstead confirms that US investors, through Q3 2013, remain focused on diversifying their equity allocations but while emerging market equities are still being bought, the pace of acquisition has drastically reduced.
“In Q3 we saw USD2.2bn of net inflows in EM equities among US-domiciled investors compared to USD11.8bn in Q2 and USD22.7bn in Q1 2013. So there’s clearly been a slowdown this year. As for debt, it seems global debt products remain interesting to both US and Asian investors. We see a lot of assets going into global multi-sector and global high-yield products.”
One significant trend is the rising prominence of floating rate bank loans; one of the top 10 most searched universes by consultants on the eVestment database in Q3 2013.
“2012 and year-to-date 2013, USD70.9bn has been invested in floating rate bank loans by US investors. The last quarter alone saw USD20.3bn of inflows, Q2 saw a USD12.8bn gain and Q1 saw an USD18.4bn gain. So there’s been a tremendous amount of inflows to this asset class. If you think about where we stand today as an economy with historically low interest rates, this makes sense. Floating rate fixed income has a premium over traditional fixed income categories and, because it is pegged to interest rates, investors will be protected when interest rates eventually rise,” says Olmstead.
Correlating investor and consultant behavior to asset flows
The ability to see what consultants are searching for makes it possible to see how investor sentiment is changing – prior to allocations. Whereas asset allocation trends are more backward looking, consultant search trends offer a forward-looking snapshot.
This is particularly interesting when one considers that US investors have been selling US equities this year (perpetuating the anti-home court bias). However, search activity is on the rise. Will US investors stick to their guns and continue allocating elsewhere, or will this increased search activity into US equity products translate into domestic inflows in 2014?
“We haven’t seen the asset flows come back yet, but behind the scenes we can see that search activity is increasing and might suggest that if we continue on the path to US economic recovery, we will see a rebound in US equities,” opines Olmstead.
Asian plans are increasing their allocations to US equities, as already mentioned. Whether US plans will follow suit is one of the big questions open to debate.
In many respects this should be a no-brainer; after all, US equities have vastly outperformed emerging market equities. A US plan that had held US equities would have enjoyed annualised returns of around 20% over the last three years. Emerging market equities have delivered nowhere near that; the MSCI Emerging Markets Index has made net gains of 4 to 5% only since 2011.
“It appears that perhaps some of those flows are returning to US equities just based on the sheer volume of search activity we see but it remains to be seen whether it will translate into meaningful inflows,” Olmstead observes.
Analysis of future asset flows
As eVestment wrote in its October report on consultant and plan sponsor database search trends, floating rate bank loan strategies have attracted USD35bn in inflows over the last five quarters. Endowments and foundations have actually increased their allocations to these strategies for eleven consecutive quarters. Insurance companies bought USD2.5bn in the first six months of 2013.
This particular search trend will likely continue as investors look to protect against interest rate hikes. The majority of investors in this relatively new asset class are US investors targeting floating rate bank loan strategies centered on US banks.
The eVestment database is used by 84% of the top 50 consultants who together are responsible for moving trillions of dollars of assets. The database tracks 300 different investment universes each day. Where the data becomes predictive, statistically, is with respect to the top decile searches; that is, the top 30 product searches.
What eVestment has found is that universes in this top decile for search activity receive 57.9% more flows in the following quarter. Not a bad predictive tool for where future asset allocations might head.
More compelling though, is when looking two quarters into the future. Remember, institutional plans take time to rotate their allocations, it doesn’t happen instantly. There is a natural lag time.
“Based on the consultant search results for Q3 2013, we can make even stronger predictions for Q2 2014. Universes within the top decile receive 99.7% more flows than peers two quarters out compared to 57.9% one quarter out. That tells us that the top 30 searches for October have a very high chance of receiving assets in the second quarter of 2014.”
Taking it a step further, the top 10 searches by product, representing 3% of the searchable universe, have the most likely chance of receiving those inflows, but, equally, could also be at greatest risk of suffering outflows. After all, it is not possible to discern whether consultant searches are in response to increased or decreased appetite among institutions.
So what do investors want right now? What are the top decile products being searched? According to eVestment’s data, the top three products for Q3 2013 were: Global multi-sector fixed income (more than 90% of search activity), emerging markets all-cap equity (approximately 87%) and emerging markets small-cap equity (approximately 80%). Frontier markets equity rounded out the top 10 with slightly north of 60% search activity.
“This is a pretty good predictor of where asset flows are likely to go in Q2 2014,” adds Olmstead.
As for specific product names, Aberdeen EM Equity came out on top followed by PIMCO: Unconstrained Bond and Walter Scott: Global Equity.
Because the data can be sliced by geography, eVestment can also make some interesting predictions there. If one looks at the top three searches for Japanese, Asia ex-Japan and Australian investors, all three Asian markets are currently looking at global debt; a clear sign that this asset class will likely to continue receiving inflows next year. UK equity and debt were among the bottom three searches among Asia ex-Japan investors, thereby suggesting that these assets will continue to be avoided in early 2014.
As for the key message in all of this, Olmstead responds by saying: “The key message is basically that we continue to see the diversification of plans. We continue to see the plan sponsors of institutional investors moving in different directions globally, with some, for example US plan sponsors, moving into new asset classes like floating rate bank loans. At the same time, there remains a global de-risking trend where plans want geographically diversified rather than country-specific products.”