Institutional investors are concerned about generating returns and navigating a low-yield environment as they make plans for 2016, according to a report released by Natixis Global Asset Management.
In response, these investors plan to increase allocations to equities and alternative investments, while decreasing exposure to fixed income.
Natixis surveyed 660 institutional investors in October around the globe to find out their year-ahead market outlook and asset allocation plans.
The online survey, conducted in October, included a range of public and private pension managers, insurers, sovereign wealth funds, foundations, endowments and central bankers.
From that survey, Natixis found alpha is becoming harder to obtain for these institutional investors as markets become more efficient.
“Successful implementation of portfolio strategy in 2016 will require walking a tightrope between risk, return and yield,” the report says. “If they are to meet their primary objective of achieving their return targets while staying within their risk budgets, institutions will likely seek added help from outside specialists in their execution of investment plans.”
Based off of Natixis’ survey results, here are five of institutional investors’ predictions for 2016.
1. High Hopes for Equities
Institutional investors, according to the survey, see opportunities to generate returns from growing equity markets around the world. Natixis found that institutional investors believe equities are poised to outperform in the next 12 months – with more than four in 10 respondents (42%) thinking global equities will most likely be among the top performers. Respondents also had varying faith in U.S. equities (33%), emerging equities (25%) and domestic equities in their home countries (15%).
Beyond the traditional equity classes, 20% of respondents say private equity investments will be among the best in class for 2016.
“The institutional outlook for equities may not just be optimism for stocks so much as a commentary on the state of the bond markets,” David Lafferty, Natixis Global Asset Management chief market strategist, said in a statement. “Interest rates are low globally and negative in a third of European bond markets. These investors would rather tie themselves to corporate growth in stock than to sovereign stagnation in bonds.”
2. Commodities and Fixed Income to Falter
Natixis found an overwhelming pessimism among institutional investors when it comes to the fixed income side of the equation.
“With the U.S. dollar continuing to strengthen against other global currencies, institutional decision makers project that commodities, such as precious metals, are likely to underperform other investments,” the report states.
According to the survey, 36% of the respondents placed commodities within their three worst performers. Another 21% cited natural resources, including energy and timber, as a worst performer.
Thanks to the low to negative interest rates in Europe and the prospect of rising rates in the U.S., a range of fixed income classes are sitting on institutional investors’ worst performers list.
According to the survey, emerging market bonds (32%), global bonds (25%) and domestic bonds (21%) round out the list of worst performers.
3. Adjusting Portfolios for Rising Rates
While a majority of investors (84%) are concerned about the low-yield environment, they also express confidence in their ability to manage interest rate sensitivity within their portfolios.
And because of this concern – if the U.S. Federal Reserve and other central banks raise rates from their historic lows – institutional investors are poised to make several portfolio modifications.
According to Natixis, the majority (65%) of respondents will move from longer-duration bonds to those with shorter durations – or already have made that adjustment.
Natixis also found a significant portion of institutions are planning on decreasing their use of bonds in the New Year.
On average, institutions currently allocate 28% of their portfolios to fixed income, according to Natixis. But, over the next year, 42% of institutions expect to decrease that share. This is “the largest allocation decrease of all asset classes,” Natixis says.
The same percentage of institutional investors (42%) plan to maintain their allocation to fixed income, and only 16% plan to increase it.
Other adjustments include raising their allocations to alternative investments (47%) and using absolute return strategies (32%).
4. Volatility Will Be No. 1 Risk
According to Natixis’ survey, more than four in 10 respondents (42%) believe market volatility will be the number one risk to investment performance in 2016.
“After a year in which we saw 56 days with 1% movement in the S&P 500 between Jan. 1 and Oct. 31, it should be no surprise that this weighs on the minds of investors,” the report says.
More than half of institutions (54%) predict global politics will be the No. 1 cause of market volatility next year, according to the survey. Natixis also finds that investors are concerned about the risk of economic woes in China (49%), differing international monetary policies (47%) and changes in interest rates (46%).
5. Alternatives a Case of Function Over Form
Fifty-four percent of respondents said traditional assets were too highly correlated to provide distinct sources of return, while 56% said they believed their alternative holdings would perform better in 2016 than in 2015.
Natixis finds that institutions are looking to alternatives to fit a range of portfolio functions, with enhanced diversification (64%), enhanced alpha (50%) and risk mitigation (49%) ranking as their top three portfolio applications.
“Knowing that institutions expect to increase allocations to a range of alternative investments, it is interesting to note how they plan to apply these strategies within their portfolios,” the report states.
Over the next year, many institutional investors will raise their holdings of noncorrelated assets, including 50% who will increase private equity holdings and 46% who will increase private debt, while 41% will increase allocations to hedge funds.
Nearly half (42%) of institutions expect to decrease their allocation to bonds.
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