The world's institutional investors are confident in their ability to meet their long-term objectives despite geopolitical and market risks in the coming years, according to survey findings from Natixis Global Asset Management. They expect stocks will be the best-performing assets in 2015 and believe alternative assets are necessary to manage liabilities and risk.
Institutional investors are an important source of long-term finance. Pension funds in particular must achieve sufficient returns to meet immediate and future obligations, especially as plan beneficiaries live longer. However, the survey found that institutional investors face short-term performance pressures. As a result, investors say they're more likely to play it safe and reduce the risks in their portfolio in the next year.
Natixis' Durable Portfolio Construction Research Centresurveyed 642 institutional investors, including public and corporate pension funds, sovereign wealth funds and insurers spanning 27 countries. The respondents collectively manage US$31 trillion in assets. The survey showed:
* Confidence in meeting liabilities: While 87% expect to meet their long-term liabilities, more than half of the respondents believe most other organizations will fail to do so (consistent with results from last year's survey).
* Striking a balance between future and immediate needs: 80% of institutions say it is challenging to generate stable returns, while 68% of investors expect it will be difficult to manage liabilities linked to increased longevity.
* Stocks and alternatives are favored: 43% expect stocks to be the strongest asset category next year. Another 28% identify alternative assets as top performers, followed by bonds (13%), real estate (7%), energy (3%) and cash (2%).
* A fear of world political and economic crises: The top four potential threats to investment performance in the next year are geopolitical events (named by 17% of institutional investors), European economic problems (13%), slower growth in China (12%) and rising interest rates (11%).
* A modest assessment of returns: On average, institutions expect they can earn yearly returns of 6.9% after inflation. They are likely to seek that return carefully in 2015: by a margin of 38% to 16%, investors say they plan to lower risk in their portfolios next year.
"Institutional investors have an enormous fiduciary responsibility to fund current goals and meet future obligations," said John Hailer, president and chief executive officer for Natixis Global Asset Management in the Americas and Asia. "The current market environment makes it difficult for institutions to earn the returns that are necessary to fulfill both short-term and future responsibilities. Building a durable portfolio with the proper risk management strategies can help investors strike a balance between pursuing long-term growth and minimizing losses from volatility."
Despite the expected challenges, institutional investors are confident in their ability to meet their liabilities. Eighty-seven percent anticipate they'll take care of future obligations. But 52% say most of their peer organizations will fail to do so. (The latter figure is 4 percentage points lower than in Natixis' 2013 survey.)
Interest rates worries; advice for investors
As they look ahead, institutional investors are wary that higher interest rates will contribute to choppy markets. Two-thirds of investors (67%) expect difficulties over the next three years linked to rising interest rates and 81% say it will be tough to manage volatility in that time.
According to the survey, as rates rise, institutional investors will adjust their bond portfolios and allocations. Sixty-one percent would move from long- to shorter-duration bonds, while others plan to reduce exposure to fixed-income (46%). More than a third (36%) would increase their use of alternative strategies.
"Institutions want to avoid being upended by a big swing in the markets and will position their portfolios accordingly," Hailer said.
Surprisingly, institutional investors believe individuals can earn similar returns to their own. Respondents say average individuals can earn 6.5% a year after inflation, just 0.4 below the returns they expect to deliver for their organizations. Asked what advice they could provide to individual investors, the professionals say they should:
* Avoid making emotional decisions about finances: 84%
* Use alternative investing strategies: 76%
* Set a return target based on personal goals rather than market benchmarks: 62%
* Think about risk first, rather than return, when putting together a portfolio: 61%
Alternative investments critical to generating return in efficient markets
More than half (55%) of institutional investors agree that traditional assets are too highly correlated to provide distinctive sources of return. As the markets become more efficient, they are looking for new sources of performance. The survey found that most have turned away, in some measure, from traditional asset allocation and toward a greater use of alternative assets:
* 75% of investors feel that alpha is becoming harder to obtain as the markets become more efficient.
* 81% agree that alternatives are suitable for institutional portfolios and 60% say they are a good source of returns.
* 71% believe that alternatives are necessary for institutional investors to manage liabilities and longevity risk.
Fabrice Chemouny, executive vice-president and global head of institutional sales said, "Despite the cautiously optimistic outlook for 2015, Asian institutional investors are positive about their investments in alternatives, particularly towards real estate. Our survey found that Asian institutional investors are showing strong interest in property and a large majority (85%) is planning to maintain or increase their portfolios' current level of real estate. We continue to foresee strong growth in alternatives across Asia as institutions increasingly see these investments as critical to generate alpha, reduce high market correlations and manage liabilities and longevity risk."
Many investors say they believe so-called ESG investing can be both a source of return and a way to reduce risk. An ESG approach to investing takes nonfinancial factors - environmental, social and corporate governance - into account to help determine the long-term sustainability and ethical impact of an investment. The survey showed:
* 54% think that ESG investing has long-term growth and alpha benefits.
* 55% agree that ESG investing mitigates risks such as loss of assets due to lawsuits, social discord and environmental disasters.
