Institutional investors are increasingly integrating environmental, social and governance (ESG) factors into investment analysis to help manage risk and enhance returns, a report from Natixis Investment Managers says.

The top reason (47%) for implementing ESG is to align investment strategy with organizational values, the report says. A year ago, the top reason was to comply with their firm’s mandate or investment policy.

Three in 10 (29%) include ESG to generate higher risk-adjusted returns over the long term, and 56% believe ESG investing mitigates risks (e.g., loss of assets due to lawsuits, social discord or environmental harm).

The survey also found that 59% say there is alpha to be found in ESG investing, and 61% agree incorporating ESG into investment strategy will become a standard practice within the next five years.

Read: Here’s how portfolio managers are investing now

Natixis’ Center for Investor Insight surveyed 500 institutional investors around the world to gain insight about how they are balancing long-term objectives with short-term opportunities and pressures. The investors favoured the following strategies:

  • Diversification: Global macro strategies (47%), commodities (41%) and infrastructure (40%) investments were cited as best for diversification.
  • Fixed-income replacement: As interest rates rise and the 30-year bond bull market ends, top sources of stable income include infrastructure (55%) and private debt (47%).
  • Volatility management: Managed futures (46%) and hedged equity (45%) are used to manage volatility risk.
  • Alpha generation: Seven in 10 (72%) cited private equity as their top choice among alternatives for generating alpha, followed by hedged equity (45%).
  • Inflation hedge: Commodities (56%) and real estate (46%) are top inflation hedging strategies.

“The sudden return of market volatility is a healthy reminder that it’s important to take a consistent approach to portfolio diversification,” said David Giunta, CEO for the U.S. and Canada at Natixis Investment Managers, in a release.

Three-quarters (76%) of institutional investors think the current market favours active managers. While alternative investments can present a range of portfolio risks, 74% say the potential returns of illiquid investments are worth the risk.

Read: Is it time to nix the VIX?

Here are some other priorities for institutional investors:

  • Risk management: The survey found that 63% of institutions say it’s a challenge for their organization to gain a consolidated view of risks (including interest rates, volatility and geopolitics) across their portfolio. To control portfolio risk, 84% of institutional investors believe that diversification is an effective strategy; 81% find that risk budgeting is an effective tool; 46% say integration of material ESG factors is useful.
  • Managing longevity risk: This was a top concern for 78% of corporate pension plans, 76% of public pension plans and 85% of insurance firms. Longer life expectancy means funding longer retirements, which becomes harder during a prolonged low-rate environment. According to the study, prospects for continued interest rate increases are a positive for many institutions, as increases would help reduce the present value of liabilities, but would also reduce present value of bond holdings. To strike an optimal balance, institutions cite managing duration as their top strategy for navigating a rising rate environment.
  • Outsourcing: Many institutional investors (44%) outsource at least some portion of their investment management function. Among those who do, management is outsourced for approximately 41% of their portfolio. Their primary reason for doing so, according to 49% of institutions, is to access specialist capabilities. During the next 12 months, nearly one in five (17%) institutions is considering outsourcing investment decision making, a rise from 13% in 2016, or 30% more.

Read the full report, called “When. Not if.”

Also read: As markets drop, here’s how advisors are communicating

About the study: For the sixth consecutive year, Natixis surveyed 500 institutional investors, including managers of corporate and public pension funds, foundations, endowments, insurance funds and sovereign wealth funds in North America, Latin America, the United Kingdom, Continental Europe, Asia and the Middle East. Data were gathered in September and October 2017 by the research firm CoreData.

Originally published on Advisor.ca
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