Institutional investors expect more changes to asset allocations

By Jennifer Paterson, Benefits Canada | December 1, 2016 | Last updated on December 1, 2016
4 min read

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Global institutional investors are expecting to make more asset allocation changes in the next couple of years than they did in 2012 and 2014, according to a new survey by Fidelity Investments.

The anticipated shifts include alternative investments, domestic fixed income and cash. Globally, 72% of respondents said they would increase their allocations towards illiquid alternatives in 2017 and 2018, with significant percentages also saying the same for domestic fixed income (64%), cash (55%) and liquid alternatives (42%).

Derek Young, vice-chairman of Fidelity Institutional Asset Management and president of its global asset allocation division, says investors are rethinking asset allocations because they’re increasingly recognizing their obligation to drive returns. “I believe institutional investors feel that burden of trying to determine where best to be invested and, in order to do that, are willing to make allocation changes that, several years ago they would have been less likely to make,” he says. “Now they realize more of the burden is on them to make those changes.”

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In Canada and the United States, many institutional investors are adopting a wait-and-see approach, according to the survey. For example, compared to 2012, the percentage of U.S. institutional investors expecting to move away from domestic equity has fallen significantly, to 28% from 51%. At the same time, the percentage of U.S. respondents that expect to increase their allocation to the same asset class has risen by three percentage points.

In Canada, amid a move away from domestic equity and fixed income, institutional investors are adding exposure in other areas, such as liquid and illiquid alternatives, says Young. “We’ve really seen institutional investors make moves away from some of the public market areas and much more towards alternatives or, at least, they’re indicating that that’s a goal of theirs,” he says.

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“We see that showing up in both the liquid and the illiquid alternatives. If you think about what investors are looking to accomplish in terms of their investment strategies, I think they’re realizing that they’re going to have to step out and look for opportunities in asset classes that may be non-traditional in nature.”

The top concern for global institutional investors is the environment of low returns, which Young says is another reflection of organizations taking on the burden of trying to hit their targets. “So I think there is a correlation there between the low-return environment and this shift towards alternatives,” he adds.

Just over a quarter (27%) of respondents cite market volatility as a top concern, but the issues vary according to the type of institution. Globally, sovereign wealth funds (46%), public sector pension plans (31%), insurance companies (25%) and endowments and foundations (22%) are most worried about market volatility. However, the environment of low returns is the top concern for private sector pension plans (38%).

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Despite their concerns, nearly all institutional investors surveyed (96%) believe they can still generate alpha over their benchmarks to meet their growth objectives. More than half (56%) of survey respondents said growth remains their primary investment objective. The finding was similar to the 52% that said the same in 2014.

The survey also found global institutional investors, on average, are targeting approximately a 6% return. On top of that, respondents are confident of generating 2% alpha every year. “The reason why that’s important is I think there’s been a recognition of how influential asset allocation can be in the performance process,” says Young. “The allocations themselves tend to be a larger driver of under and over performance than the underlying strategies. So you see institutions relying more and more on their ability to make the right calls in active allocation.”

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Globally, institutional investors report they consider a number of qualitative factors when they make investment recommendations. At least 85% of survey respondents say board member emotions (90%), board dynamics (94%) and press coverage (86%) have at least some impact on asset allocation decisions, with about one-third reporting those factors have a significant impact.

“What’s interesting is seeing the influence of the behavioural biases that show up, so the emotional impact of decisions that are being made at the board table is significant,” says Young. “It’s what you would expect in terms of when you’re going through volatile environments like we had back in 2008. But as the market has stabilized more, it’s a surprise that you still see emotion having such a strong play at the table.”

Jennifer Paterson, Benefits Canada