Portfolio > Portfolio Construction > Investment Strategies

5 Ways Big Investors Are Challenging Traditional Investment Strategies

Your article was successfully shared with the contacts you provided.

Faced with volatility, greater risks and still-low yields, institutional investors are re-evaluating traditional investment strategies, according to an international survey of institutional investors published on Tuesday by Natixis Global Asset Management.

Institutional investors’ primary investment goal in 2017 is to achieve the highest risk-adjusted annualized return. Given the prospect for greater volatility and persistence of low interest rates, few institutions are relying on traditional portfolio strategies to meet their performance goals.

Instead, institutions are increasing their exposure to equities and alternatives and turning to illiquid assets and the private markets for risk-managed return generation and yield replacement.

“While risk factors change over time, the challenge for institutional investors remains to deliver long-term results while navigating short-term market pressures,” said David Giunta, CEO for the United States and Canada, in a statement. “Given their mandates, avoiding risk is not an option for institutional investors. They have to beat the odds or change the game, and they are doing so by balancing risks and embracing alternatives to traditional 60/40 portfolio construction, but always with an eye on their long-term objectives.”

Natixis surveyed 500 managers of public and corporate pensions, foundations, endowments, insurance funds and sovereign wealth funds in North America, Latin America, the United Kingdom, Continental Europe, Asia and the Middle East. Collectively, they manage $15.5 trillion in assets.

The findings provide insight into how institutional investors are seeking to use risk to their advantage. Here are five ways institutional investors are challenging traditional investment strategies. A bigger role for alternative investments

1. Institutions see a bigger role for alternatives.

Challenged to find yield in recent years, a majority of institutions believe they must replace traditional portfolio construction techniques if they are to achieve results.

According to the survey, 67% believe it is essential to invest in alternatives to diversify portfolio risk.

While liquidity limits the ability of 55% of institutions to invest in alternatives, the concern may be waning as almost the same number (56%) report that their organization is embracing illiquid assets today more than three years ago, according to the survey.

Private investments are taking on greater importance

2. Private investments are taking on greater importance.

Whether it is debt or equities, private investments fill important roles within institutional portfolios. The survey finds that six in 10 institutional investors say private debt provides better diversification than traditional fixed-income vehicles, while more than half say private equity provides a similar advantage over investment in traditional equities.

“Challenged to produce results with public securities, institutional investors are increasingly turning to private markets in search of more attractive returns,” the report states.

Institutional investors agree that both private debt (73%) and private equity (67%) are better suited to helping to deliver on their number one investment goal: delivering higher risk-adjusted returns.

Institutions say they would consider the following private debt investments in the next 12 months: direct lending (44%), collateralized debt (34%), special situations (34%) mezzanine (27%) and distressed debt (26%).

Meanwhile, in private equity, institutional investors say the top three most attractive investments will be: technology, media and telecom (37%); infrastructure (34%); and health care (26%).

Few investors are relying on traditional risk management strategies like diversification

3. Few investors are relying on traditional risk management strategies.

While a little over half of respondents (54%) believe that diversifying across traditional asset classes can provide adequate downside protection, just 3% strongly believe this strategy will be enough to do the job in the coming year. Instead, investors believe more effective techniques for managing portfolio risk are through risk budgeting (87%), diversifying holdings across sectors (86%), currency hedging (75%) and increasing their use of alternative investments (76%).

In terms of managing risk, the top concerns for institutional investors are low-yield environment (67%), interest rates (48%) and ability to fund long-term liabilities (34%).

Nearly seven in 10 report they are willing to underperform their peers to ensure downside protection.

Outsourced investment management

4. Institutions report an uptick in outsourced management to access specialist capabilities.

The survey finds that 42% of the institutions surveyed say some or all of their portfolio is managed by an outside chief investment officer or fiduciary manager. And, of those who outsource, 37% of their total portfolio on average is managed by an outside CIO or fiduciary manager.

The primary reasons for outsourcing the fiduciary manager/CIO function are to access specialist capabilities and expertise (34%) followed by investment performance (26%), according to the survey.

And more institutions may be jumping on the outsourcing bandwagon. According to the survey, 13% of institutional investors are considering hiring a fiduciary manager or outsourcing their CIO function within the next 12 months. This is up slightly from the 2015 survey, where 11% of those surveyed were considering outsourcing their CIO function in the next year.

State Street, which installed this statue, said it would encourage companies to hire more women on their boards. (Photo: Federica Valabrega)

5. Environmental, social and governance investing is taking on broader importance.

The survey finds that 62% of institutions agree that incorporating ESG will be a standard practice for all managers within five years, which is up from last year. When asked the same question in the 2015 survey, 44% of institutional respondents agreed.

More than half (52%) of those surveyed report their organization integrates ESG factors in their fundamental process, rather than a separate ESG division.

More investors are starting to believe there is alpha in ESG investing. According to this year’s survey, 58% agree there is alpha to be found in ESG investing. In the 2015 survey, 50% of institutional managers surveyed said ESG investments could be a source of alpha.

— Related on ThinkAdvisor:

More on this topic