Institutional investors anticipate a year of “dramatic change” in 2017, according to a new survey from Natixis Global Asset Management, and that (possibly) includes down-and-out 401k active management.
World political and economic events could push the level of market volatility higher in 2017, Natixis finds. As a result, institutional investors plan to “reset their portfolios, relying on active management and alternative assets as they seek to manage risk and boost returns.”
Natixis surveyed decision makers at 500 firms. Volatility topped the list of concerns, with 65 percent pointing to geopolitical events, 38 percent citing the U.S. elections, and 37 percent noting the potential for changing interest rate policies.
“Unprecedented economic and political forces around the world are the top concern for institutions in 2017,” John Hailer, CEO of Natixis Global Asset Management for the Americas and Asia and Head of Global Distribution, said in a statement. “In volatile markets, institutions are looking to active management to strengthen returns and manage risk.”
Pros Choose Active Management Over Passive
Especially in anticipation of higher volatility, institutional investors favor active management over passive. They also express concern over the market distortions caused by passive investing:
- 73 percent say the current market environment is likely favorable to active management
- 78 percent say they are willing to pay a higher fee for potential outperformance
- 49 percent say passive investing distorts relative stock prices and risk-return trade-offs
- 64 percent 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 percent of their assets are actively managed and 33 percent are in index-tracking investments, and they expect the share of passive investments to rise only one percentage point, to 34 percent, in the next three years.
In a 2015 Natixis survey, investors expected 43 percent of assets would be passively managed within three years.
The main reason for using passive strategies, cited by 88 percent of respondents, is a desire to manage fees, but 57 percent 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 percent) 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.
Move to alternatives tops asset allocation trends
Half (50 percent) of surveyed institutional decision-makers across the globe plan to increase their use of alternative strategies in 2017, with two-thirds (67 percent) using them for diversification and a third (31 percent) for risk mitigation. Emerging market equities, high yield fixed income and financials are other big winners.
The survey also found:
- Use of alternatives rises: Institutional investors will shift more toward alternative investments in 2017, raising their allocations to 22 percent from 18 percent of assets. They will increase equity allocations slightly, to 36 percent from 34 percent, and dial back on fixed income, to 32 percent from 35 percent.
- Biggest winners of 2017: Among stocks, 39 percent of investors predict emerging markets equities will be the biggest gainers next year. Within alternatives, 32 percent say private equity will do the best. And among bonds, 53 percent think high-yield issues will outperform.
- Possible disappointments: On the other hand, investors say U.S. stocks (named by 41 percent), medium- to long-term government bonds (67 percent) and, among alternatives, real estate (29 percent) could trail the pack.
- Sector picks: 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.
U.S. Presidential Impact
The responses also showed that institutional investors’ confidence suffered after the U.S. election. Natixis conducted the survey in two stages, with 340 investors polled just before the U.S. presidential election on Nov. 8 and 160 responses collected just afterward. Prior to the election, two-thirds of respondents expressed confidence in their organization’s ability to handle the risks associated with investment performance, which fell to only 53 percent among those surveyed after the election.
The outlook for U.S. and emerging market stocks also changed substantially after the election. Forty-three percent (43 percent) of investors surveyed before the election said emerging markets would be the best-performing equity market in 2017 compared to 31 percent of those surveyed after the election. Meanwhile 46 percent of those surveyed before the election said the U.S. would be the biggest disappointment among global stock markets, compared with 31 percent 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 percent before the election to 76 percent afterward.
A global wave of populism is upending conventional thinking about politics and economics. Central bank policies, which have driven investment performance for nearly a decade, are beginning to diverge. The U.S. Federal Reserve is likely to raise rates, while other central banks are challenged to scale their asset purchase programs. The upshots are concerns among institutional investors about volatility, geopolitical risk, and monetary policy, which we see them addressing using a three-part approach:
- Alternatives for diversification: Looking at a market that could be marked with a double-hit of increased volatility and rising interest rates (at least in the U.S.), institutions say they will dial back on fixed-income allocations, and two-thirds of institutional investors globally say it is essential to invest in alternatives in order to diversify portfolio risk.
- Sector calls: In looking at sector performance, institutional investors are split on just what will result in a big gain or a big loss in 2017. Financials sit atop the projections for the biggest gainers but also rank second, behind utilities, as the biggest disappointment in the year ahead. The divergence of opinion indicates a clear philosophical split.
On the heels of a tumultuous political year, institutional investors believe that geopolitical volatility will translate into market volatility for investors in 2017. Navigating the volatility will mean resetting investment priorities and revisiting investment strategy.
With more than 20 years serving financial markets, John Sullivan is the former editor-in-chief of Investment Advisor magazine and retirement editor of ThinkAdvisor.com. Sullivan is also the former editor of Boomer Market Advisor and Bank Advisor magazines, and has a background in the insurance and investment industries in addition to his journalism roots.
