The coronavirus pandemic has upended the global economy this year, and anxiety about its long-term effects tempers institutional investors’ optimism for growth in 2021, according to a new survey from Natixis Investment Managers.
Institutions see alpha opportunities amid rising volatility and a market inching forward, but 78% think the stock market’s current pace of growth is unsustainable, and they expect performance in the year ahead to be hard won and fragile.
Markets have proved remarkably resilient during this tumultuous year, and 64% of investors surveyed said they intend to keep as is or even to raise their return assumptions.
The survey found institutional investors’ long-term return assumption is 6.3% on average, down 60 basis points from 2019. Insurers have cut their return assumption even more sharply, from 6.5% to 5.5% on average.
The survey results showed that institutions’ broad asset class allocations will remain relatively unchanged, with 36% in stocks, 40% in bonds, 17% in alternatives and 6% in cash.
Yet institutional investors are taking advantage of what they expect will be increased dispersion in the markets in 2021, making many tactical adjustments within asset classes, notably these:
- Trimming U.S. equities, and increasing European, emerging market and Asia/Pacific stock exposure
- Decreasing exposure to government bonds, and adding investment-grade corporate debt and securitized loans
- Broadening alternative strategies with more private equity and infrastructure investments
“With the pandemic, politics and global economies at an inflection point, institutional investors are positioning their portfolios to navigate short-term volatility while anticipating the long-term impacts of this year’s massive economic and market interventions,” David Giunta, chief executive for the U.S. at Natixis Investment Managers, said in a statement.
“Investors’ outlook reflects deep concerns about the lasting consequences of the extreme measures needed to cushion the financial blow of the pandemic. However, they also see opportunities to find value through active management, thoughtful portfolio allocation and diversification.”
CoreData, a research firm, conducted a survey in October and November among 500 managers of corporate and public pension funds, foundations, endowments, insurance funds and sovereign wealth funds in North America, Latin America, the U.K., Continental Europe, Asia and the Middle East that collectively manage some $13.5 trillion in assets.
In the year ahead, 58% of institutional investors expect value to outperform growth, while 53% expect large cap to outperform small cap, according to Natixis.
Slightly more than half of institutional investors think emerging markets will outperform developed ones, though the vast majority agree on the need to be more selective in pursuing emerging market opportunities.
Despite pushback on the size and influence of Big Tech, seven in 10 institutional investors expect the growth of technology companies to surge ahead. They see information technology and health care as the big winners in next year’s market, and energy, real estate, consumer discretionary and financials as underperformers.
Forty-four percent of survey participants believe a stock market correction is due, and 41% say the same about the real estate sector, as do 39% about the tech sector and 29% about the bond market.
Eight in 10 say equity factor diversification is an important consideration in their risk management strategy. Although 71% of institutional investors say they are willing to underperform their peers to ensure downside protection, 53% believe that defensive strategies will outperform a more aggressive approach in 2021.
Top-of-Mind Issues in 2021
How will institutions address the risks and opportunities of an uncertain 2021? “The Covid economy, politics and policy, and an increased focus on valuations are all colliding to shape institutional portfolio strategy in the year ahead,” Dave Goodsell, executive director of Natixis’ Center for Investor Insight, said in the statement.
“But even when faced with what they see as a risky landscape, institutional investors believe investment opportunities can be found — those who know where to look will likely be the ones to outperform.”
Following is a look at the key issues shaping institutional investors’ outlook for the year ahead.
COVID-19 will loom large over the economy and markets for years to come.
Some 80% of institutional investors believe the global economy cannot escape the consequences of the global pandemic. Seventy-three percent believe the pandemic-induced “new normal” is here to stay. Forty-four percent look out as far as 2022 for GDP growth to return to its pre-coronavirus level, while a more pessimistic 35% do not expect full economic recovery until 2023 or later.
Long-term risks outweigh today’s political uncertainty.
Global political uncertainty has rattled the markets in the four years since the U.K.’s Brexit vote and Donald Trump entered the Oval Office. Eight in 10 institutions see more populist political contenders emerging in the current political climate, and 77% think social unrest will continue to rise. At the same time, seven in 10 expect geopolitical tensions to escalate, and three-fourths expect democracy to grow weaker globally.
Ultimately, 78% of institutional investors believe that the outcome of political elections will influence the markets less than central bank policies do. They trust that central banks will backstop the markets in the event of another serious downturn, but 78% believe that actions taken to quell the initial coronavirus shock will have long repercussions.
Many believe that policy decisions, including rate cuts and fiscal stimulus provided by governments, increased the risk of a financial crisis and decreased government’s capacity to respond to future crises. Sixty-five percent also believe that taxes will inevitably rise, and 44% think cuts to social safety net programs, including pension benefits, will be necessary.
A riskier world means greater market risks.
Negative interest rates topped institutional investors’ list of portfolio risk concerns in 2021. Eighty-two percent say low rates have distorted market valuations, and 53% expect to see the volume of negative yielding securities rise next year. Seven in 10 respondents believe institutional investors are taking on too much risk in pursuit of yield. Fifty-two percent cite volatility as a top portfolio risk, particularly since 65% expect stock market volatility to increase next year and 55% expect to see greater volatility in currencies.
There is opportunity amid volatility.
Increased volatility has a silver lining as 52% of institutional investors also expect to see greater dispersion, or variation in performance between different investments, next year, which could provide opportunities to outperform their benchmarks. Seventy-nine percent agree that the market environment in 2021 will be favorable to active portfolio management, and 67% think active investing will outperform.
Passive investing can’t be ignored.
Eighty-two percent of institutional investors say current valuations do not reflect company fundamentals. While there are a number of contributing factors, 58% think the widespread use of passive investments has simply caused the market to ignore fundamentals. Seventy-one percent of institutions worry that large flows into and out of index funds exacerbate market volatility. And to the extent that that is driven by retail investors, 63% of institutions do not believe the latter add valuable price signals to the market.
Private equity and private debt provide powerful portfolio alternatives.
Institutional investors continue to look to private markets for attractive long-term growth and to help meet their long-term return assumptions. Roughly 80% are currently using private equity, with 65% mainly investing in private equity funds. Seventy-four percent hold private debt through a range of strategies from direct lending and infrastructure to funds of funds and aircraft lending.
Overall, 69% of institutional investors say private assets will play a more prominent role in their portfolio strategy going forward. Forty-four percent cite liquidity risk as a top concern, and 61% worry that too much money is now chasing too few private deals. Eight in 10 feel the current fee terms are generally too high, and one in four worry that fees will increase. Forty-two percent are considering direct investment in private deals to keep fees down.
— Related on ThinkAdvisor: