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Big Investors Shun Passive Strategies Amid Volatility: Cerulli

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Institutional investors are cooling on pure-beta and passive strategies in favor of actively managed strategies with low or no correlations, according to the first-quarter 2016 edition of The Cerulli Edge. Cerulli Associates reported in its latest research that institutional investors like pensions, endowment and sovereign wealth funds, and insurance companies are considering the impact recent volatility will have on their long-term goals.

“Institutions are considering the implications of volatility and constrained liquidity on their long-term goals and beginning to rebalance portfolios accordingly,” Alexi Maravel, director at Cerulli, said in the report. ”While some are acting based on pressures outside of those in the financial markets, most are drawing lessons from the major losses experienced in 2007–2008 and taking precautions after years of post-financial-crisis gains.”

“Equity markets are struggling with the worst start to a calendar year in a decade and interest rates are near historical lows. Beneath the headlines are numerous indications of a change in the ‘risk-on’ approach that has benefited so many investors,” Maravel added. “Conversations with both institutions and asset managers seem to begin and end with concerns about corporate spread widening and bond market liquidity.”

Third-quarter 2015 corporate earnings for S&P 500 companies fell 4.5% year over year, Cerulli found, and investment-grade corporate bonds suffered “significant yield-spread widening” last year.

Cerulli noted that although search activity for active equity strategies “spiked” at the end of 2015, actual commitments were low. U.S. institutional passive equity strategies had outflows of nearly $25 billion in the second quarter, but $5 billion in inflows the following quarter. “It may be too early to claim a wholesale institutional shift to alternative or volatility-managed strategies, but the interest is certainly there,” according to the report.

Absolute return strategies were particularly popular, with $4.7 billion in institutional assets. Outflows for “all of 2014,” according to Cerulli, were $852 million. Inflows were over $900 million as of September 2015.

Corporate pensions are especially keen to de-risk portfolios, with some “completely transferring pension liability off their books,” according to the report. It found that in 2000, the top 100 corporate pensions had an almost 123% funded ratio. By 2014, that fell to 81.7%, with early estimates for 2015 aggregate funded status the same or only slightly better.

“Despite these issues, pension de-risking may just be gaining steam,” according to the report. An average 43% of corporate pensions are still open.

“Cerulli believes that growth in the [liability-driven investing] market will come to pass, though the road will not be a straight line, owing to bond market technical factors, liquidity, and residual corporate resistance to adopting liability-hedging strategies with long-duration fixed income.”

Cerulli predicted LDI strategies will include more multi-asset-class solutions. Long-duration fixed income is used to hedge liabilities by more than 72% of respondents to a Cerulli survey. Multi-asset-class solutions (MACS) include target date, managed volatility and absolute return strategies.

— Read Don’t Bet on Active Management to Beat the Volatile Market on ThinkAdvisor.