Institutional investors worldwide are expecting to make more asset allocation changes in the next one to two years than in 2012 and 2014, according to the Fidelity Global Institutional Investor Survey.
Now in its 14th year, the Fidelity Global Institutional Investor Survey examines the top-of-mind themes of institutional investors. Survey respondents included 933 institutions in 25 countries with USD21 trillion in investable assets.
The anticipated shifts are most remarkable with alternative investments, domestic fixed income, and cash. Globally, 72 per cent of institutional investors say they will increase their allocation of illiquid alternatives in 2017 and 2018, with significant numbers as well for domestic fixed income (64 per cent), cash (55 per cent), and liquid alternatives (42 per cent).
However, institutional investors in some regions are bucking the trend seen in other parts of the world. Many institutional investors in the US are, on a relative basis, adopting a wait-and-see approach. For example, compared to 2012, the percentage of US institutional investors expecting to move away from domestic equity has fallen significantly from 51 to 28 per cent, while the number of respondents who expect to increase their allocation to the same asset class has only risen from 8 to 11 per cent.
“With 2017 just around the corner, the asset allocation outlook for global institutional investors appears to be driven largely by the local economic realities and political uncertainties in which they’re operating,” says Scott E Couto (pictured), president, Fidelity Institutional Asset Management. “The US is likely to see its first rate hike in 12 months, which helps to explain why many in the country are hitting the pause button when it comes to changing their asset allocation.
“Institutions are increasingly managing their portfolios in a more dynamic manner, which means they are making more investment decisions today than they have in the past. In addition, the expectations of lower return and higher market volatility are driving more institutions into less commonly used assets, such as illiquid investments,” he says. “For these reasons, organisations may find value in re-examining their investment decision-making process as there may be opportunities to bring more structure and accommodate the increased number of decisions, freeing up time for other areas of portfolio management and governance.”
Overall, the top concerns for institutional investors are a low-return environment (28 per cent) and market volatility (27 per cent), with the survey showing that institutions are expressing more worry about capital markets than in previous years. In 2010, 25 per cent of survey respondents cited a low-return environment as a concern and 22 per cent cited market volatility.
“As the geopolitical and market environments evolve, institutional investors are increasingly expressing concern about how market returns and volatility will impact their portfolios,” says Derek Young, vice chairman of Fidelity Institutional Asset Management and president of Fidelity Global Asset Allocation. “Expectations that strengthening economies would build enough momentum to support higher interest rates and diminished volatility have not borne out, particularly in emerging Asia and Europe.”
Investment concerns also vary according to the institution type. Globally, sovereign wealth funds (46 per cent), public sector pensions (31 per cent), insurance companies (25 per cent), and endowments and foundations (22 per cent) are most worried about market volatility. However, a low-return environment is the top concern for private sector pensions (38 per cent).
Despite their concerns, nearly all institutional investors surveyed (96 per cent) believe that they can still generate alpha over their benchmarks to meet their growth objectives. The majority (56 per cent) of survey respondents say growth, including capital and funded status growth, remain their primary investment objective, similar to 52 per cent in 2014.
On average, institutional investors are targeting to achieve approximately a 6 per cent required return. On top of that, they are confident of generating 2 per cent alpha every year, with roughly half of their excess return over the next three years coming from shorter-term decisions such as individual manager outperformance and tactical asset allocation.
“Despite uncertainty in a number of markets around the world, institutional investors remain confident in their ability to generate investment returns, with a majority believing they enjoy a competitive advantage because of confidence in their staff or access to better managers,” adds Young. “More importantly, these institutional investors understand that taking on more risk, including moving away from public markets, is just one of many ways that can help them achieve their return objectives. In taking this approach, we expect many institutions will benefit in evaluating not only what investments are made, but also how the investment decisions are implemented.”
Nearly half (46 per cent) of institutional investors in Europe and Asia have changed their investment approach in the last three years, although that number is smaller in the Americas (11 per cent). Across the global institutional investors surveyed, the most common change was to add more inputs – both quantitative and qualitative – to the decision-making process.
A large number of institutional investors have to grapple with behavioural biases when helping their institutions make investment decisions. Around the world, institutional investors report that they consider a number of qualitative factors when they make investment recommendations. At least 85 per cent of survey respondents say board member emotions (90 per cent), board dynamics (94 per cent), and press coverage (86 per cent) have at least some impact on asset allocation decisions, with around one-third reporting that these factors have a significant impact.
“Institutional investors often assess quantitative factors such as performance when making investment recommendations, while also managing external dynamics such as the board, peers and industry news as their institutions move toward their decisions. Whether it’s qualitative or quantitative factors, institutional investors today face an information overload,” says Couto. “To keep up with the overwhelming amount of data, institutional investors should consider revisiting and evolving their investment process.
“A more disciplined investment process may help them achieve more efficient, effective and repeatable portfolio outcomes, particularly in a low-return environment characterised by more expected asset allocation changes and a greater global interest in alternative asset classes.”