Professional fund buyers' decisions can provide other investors guidance on risk, asset allocation and the investment strategies most likely to succeed in current and future economic conditions.
This year, there is good and bad news in the advice fund buyers - responsible for selecting funds included on private bank, insurance, fund-of-fund and other retail platforms – are offering. The bad news is that the next 12 months are unlikely to be easy: 83% say they expect greater volatility in equity and fixed interest markets, 78% say rates will rise and 63% say the US bull market is likely to end. At the same time, geopolitical uncertainty, in particular the ongoing and escalating trade dispute between the US and China, will weigh on performance.
The good news is that professional fund buyers are confident they can tackle what’s to come. The results of this year’s global survey of 200 of these key investment decision-makers, conducted by Natixis Investment Managers, reveal the directions they are likely to take to satisfy the demands of their firms’ clients.
To seek or not to seek risk in a low-growth world?
There is always a trade-off between:
- taking on enough risk to achieve performance
- preserving wealth by not losing capital, and
- going backwards because you took on too much.
Striking the balance has become more difficult than ever as ‘lower for longer’ is the new status quo. Short-term measures aimed at navigating short-term economic weaknesses are unlikely to succeed. Investors must deal with the economic environment they find themselves in, not the one they would like to have (and have had over the past decade).
The good news is that the 200 professional fund buyers surveyed say their long-term return assumption remains pretty solid. It's down from 8.4% p.a. last year to a robust but nonetheless healthy 7.7% p.a. this year.
Professional fund buyers, like investors generally, must trade off long-term investment goals (enough money to retire on, for example) with the more immediate demands of advisers and clients for above-average performance. The result is that fund buyers’ time horizons tend to be shorter than many institutional investors and superannuation trustees, but longer than that of individual investors. Say between 5 and 10 years typically.
Risk-on as tough times call for risk assets and active management
The first overarching theme is the focus on active rather than passive investment strategies. All fund buyers acknowledged that passive index-based investment strategies have a role in a portfolio, and smart beta was singled out as a way of mitigating the risks associated with lower returns from markets generally.
However, only a quarter of these funds are managed passively, with three-quarters supporting the view that actively-managed investments are likely to outperform. There is a widespread belief that alpha is becoming more difficult to obtain and that paying higher fees for potential outperformance is acceptable. In fact, they continue to rely on the performance potential of active management to balance the competing pressures of growth and safety.
The bias towards risk assets is continuing. While allocations to equities are slightly down, there is acceptance that the higher risk is worth the potential for higher returns over time. When it comes to other ‘higher risk’ investments such as hedge funds or alternative strategies, fund buyers tend to favour liquid versions of these strategies given their end-clients typically require liquidity. Most do not serve their clients’ interests by investing in physical infrastructure investments, for example.
About 60% of fund buyers said that financial regulations put in place after the GFC have done little to mitigate current and future market risks.
Allocations are not wildly different but there are some changes
Projected portfolio allocations remain unchanged on the whole, but meaningful changes within asset classes are on the horizon. Equities and fixed interest retain their place at the top of the allocation tables and equities remain the first choice for growth, despite additional risk.
Within equities, however, increased diversification through the addition of global exposure is considered the best way to seize opportunities. For European equities as a class, half the fund buyers intend to increase allocations on the back of favourable valuations and earnings outlooks, whereas the other half are decreasing exposure due to persistent Brexit worries and a weak Italian banking sector. Asia-Pacific held steady. Despite the fact that growth in China is slowing, it’s still better than growth elsewhere.
Allocation to fixed interest is likely to remain steady but higher-yield bonds are out of favour due to concerns about rates rising, the economy becoming weaker and the financial strength of the high-yield issuers.
Alternatives are the ultimate de-risk asset class
Allocations to alternative asset classes are on the rise to meet performance objectives, manage risk and diversify portfolios. Some 70% of fund buyers said that their alternatives allocation will go to liquid alternatives with most calling out long-short equity, long-short credit and private debt as top choices to enhance returns. When it came to diversification benefits, real estate strategies were top of mind.
ESG themes offer attractive investments but also satisfy social responsibility, and it’s perhaps this duality that has contributed to ESG strategies becoming mainstream over the past year. The Natixis Investment Managers ESG report, released in May 2019, revealed that professional investors are leading the charge towards ESG strategies. Institutions, including Australian super funds, are integrating a wide range of ESG strategies into their portfolios. The report also showed that ESG investing is making in-roads in wholesale markets, where 65% of fund buyers say it is part of their investment practices. Two-thirds of fund buyers say that ESG factors will be standard for all managers in five years, but they acknowledge a number of challenges including a lack of demonstrated performance track record and concerns around ‘greenwashing’ of data.
Conclusion
Almost half of fund buyers have trimmed their assumed rate of return in anticipation of stock market declines and rising interest rates. Instead, they are selectively using alternative investments to meet their clients’ needs for growth and safety, as well as continuing to rely on the performance potential of active management, particularly in the unfolding riskier market environment.
Louise Watson is the Managing Director of Natixis Investment Managers Australia. This article is general information and does not address the circumstances of any individual.