World political and economic events could push the level of market volatility higher in 2017, with institutional investors turning to active management and alternative assets to manage risk and boost returns as a result, according to a study by Natixis Global Asset Management.
Natixis surveyed decision makers at 500 institutional investment firms around the world on their market outlook and asset allocation plans for 2017 and beyond. Volatility topped the list of concerns for 2017, with 65 per cent pointing to geopolitical events, 38 per cent citing the US elections, and 37 per cent noting the potential for changing interest rate policies.
“Unprecedented economic and political forces around the world are the top concern for institutions in 2017,” says John Hailer (pictured), CEO of Natixis Global Asset Management for the Americas and Asia and head of global distribution. “In volatile markets, institutions are looking to active management to strengthen returns and manage risk.”
Especially in anticipation of higher volatility, institutional investors favour active management over passive. They also express concern over the market distortions caused by passive investing with 73 per cent saying the current market environment is likely favourable to active management, while 78 per cent say they are willing to pay a higher fee for potential outperformance.
In addition, 49 per cent say passive investing distorts relative stock prices and risk-return trade-offs, while 64 per cent say active management provides better risk-adjusted returns than passive.
Over the longer-term, institutions project they will use passive investments less than they previously believed. They say 67 per cent of their assets are actively managed and 33 per cent are in index-tracking investments, and they expect the share of passive investments to rise only one percentage point, to 34 per cent, in the next three years. In a 2015 Natixis survey, investors expected 43 per cent of assets would be passively managed within three years.
The main reason for using passive strategies, cited by 88 per cent of respondents, is a desire to manage fees, but 57 per cent said the prevalence of “closet indexers” – managers who charge higher active fees for index-like strategies that closely hug their benchmark – as another reason. Three-quarters (75 per cent) of these professional investors say that individual investors are unaware of the risks of passive strategies and have a false sense of security about their use.
Half (50 per cent) of surveyed institutional decision-makers across the globe plan to increase their use of alternative strategies in 2017, with two-thirds (67 per cent) using them for diversification and a third (31 per cent) for risk mitigation. Emerging market equities, high yield fixed income and financials are other big winners.
The survey found that institutional investors will shift more toward alternative investments in 2017, raising their allocations to 22 per cent from 18 per cent of assets. They will increase equity allocations slightly, to 36 per cent from 34 per cent, and dial back on fixed income, to 32 per cent from 35 per cent.
Among stocks, 39 per cent of investors predict emerging markets equities will be the biggest gainers next year. Within alternatives, 32 per cent say private equity will do the best. And among bonds, 53 per cent think high-yield issues will outperform.
On the other hand, investors say US stocks (named by 41 per cent), medium- to long-term government bonds (67 per cent) and, among alternatives, real estate (29 per cent) could trail the pack.
Institutions predict financials will be the best-performing stock sector in 2017, while utilities could deliver the biggest disappointment. In private equity, the best sectors will be media and telecom, infrastructure and healthcare.
The responses also showed that institutional investors’ confidence suffered after the US election. Natixis conducted the survey in two stages, with 340 investors polled just before the US presidential election on 8 November and 160 responses collected just afterward. Prior to the election, two-thirds of respondents expressed confidence in their organisation’s ability to handle the risks associated with investment performance, which fell to only 53 per cent among those surveyed after the election.
The outlook for US and emerging market stocks also changed substantially after the election. Forty-three per cent (43 per cent) of investors surveyed before the election said emerging markets would be the best-performing equity market in 2017 compared to 31 per cent of those surveyed after the election. Meanwhile 46 per cent of those surveyed before the election said the US would be the biggest disappointment among global stock markets, compared with 31 per cent of those surveyed afterward. The proportion of investors who said longer-term government bonds would be the most disappointing fixed income asset class in 2017 rose from 63 per cent before the election to 76 per cent afterward.
Natixis surveyed 500 institutional investors about their opinions on risk, predictions on asset allocation, and views on market performance. The respondents included managers of corporate and public pension funds, foundations, endowments, insurance funds and sovereign wealth funds in North America, Latin America, the UK, Continental Europe, Asia and the Middle East. Data was gathered in October and November 2016 by the research firm CoreData. The findings are published in a new whitepaper, “Buckle up, it’s going to be a bumpy ride.”