The case for model portfolios
85%
85%
82%
Rapid spread of the Omicron variant and subsequent frontline labor shortages, system-wide flight cancellations, and other delays demonstrate that as the pandemic enters a third year, Covid-19 still poses a significant threat to the global economy, but with inflation at a 40-year high and interest rates ready to rise, investors have more to worry about in the year ahead.
Results from a recent survey of 436 fund selectors at leading wealth management, private bank, and insurance platforms around the world rank supply chain disruptions (51%) and less supportive central bank policy (45%) well ahead of Covid variants (40%) as top economic threats in 2022.
To go along with the economic threats, selectors see interest rates (70%), inflation (68%), and valuations (48%) as top portfolio risks. And after 18 months of relative calm, many see potential corrections for cryptocurrencies (62%), bonds (49%), stocks (46%), and tech (43%).
But these professionals, whose firms manage more than $12 trillion in client assets, are split on the best investment strategy for approaching this changing landscape: Half say aggressive portfolios will outperform, half say defensive portfolios.
One of their biggest challenges may be managing client return expectations. After seeing the S&P deliver 26.89% last year,1 fund selectors have increased their return assumptions from 7.1% to 7.8% in 2022. That may not be enough for investors, who in a separate survey set expectations at 14.5% above inflation,2 leaving an 86% expectations gap.
This is one key reason why selectors see their firms expanding model portfolio offerings, as 82% believe models allow them to provide clients with a more consistent investment experience. They’ll also address perpetually low yields with broader access to private assets. And with ESG (Environmental, Social and Governance) regulation coming into focus, many will expand their sustainable investment offerings with single strategies and model portfolios.
When it comes down to it, how they respond to three key themes will determine their success in 2022:
About the survey
2022 Fund Selector Outlook
Natixis Investment Managers, Global Survey of Fund Selectors conducted by CoreData Research in November and December 2021. Survey included 436 respondents in 25 countries throughout North America, Latin America, the United Kingdom, Continental Europe, Asia and the Middle East.
1
2022 economic outlook
Supply chain disruptions, central bank policy and Covid variants pose threats to growth
Despite global growth of 5.9% in 2021 and IMF projections of 4.9% for 2022,3 the pandemic continues to cast a long shadow as fund selectors see mounting risks in the macro headlines.
Supply chain disruptions (51%) pose the top threat as shortages in everything from shipping containers to microprocessors to pet food linger. Few see quick solutions and two-thirds believe disruptions will continue into 2023.
A successful recovery on its own may also pose a challenge as growth triggers central plans to curtail asset purchase programs. Globally, 45% of selectors rank less supportive central bank policy among their top economic concerns.
While these are repercussions of the pandemic, four in ten say variants like Omicron also pose a threat. Overall, six in ten (59%) believe the global economy cannot escape the consequences of Covid in 2022 and 44% worry that variants will impede economic recovery in their country.
Supply chain disruptions
|
Less supportive central bank policy
|
Covid variants
|
US/China relations
|
Economic growth
|
51% | 45% | 40% | 39% | 24% |
Supply chain disruptions
|
51% |
Less supportive central bank policy
|
45% |
Covid variants
|
40% |
US/China relations
|
39% |
Economic growth
|
24% |
Fund selectors are betting on the reopening trade
Despite the concerns, fund selectors do not see the lockdown economy winning out. Instead, 71% believe the reopening trade will outperform as consumers return to in-person experiences like movies, restaurants, and travel. Similarly, many predict that revenge spending will factor into growth as individuals treat themselves with long-delayed purchases of cars and other big-ticket items.
Energy tops sector calls
Commitment to the reopening trade comes across loud and clear in sector calls for 2022. Energy (54%) tops the list of potential outperformers. Prices have certainly climbed along with inflation, but a long-term view suggests energy will benefit as the economy picks up and demand increases.
Interest rate hikes may factor into thinking on financials with 51% projecting outperformance. A call that suggests they see a sector poised to capitalize on the spread between the rates they pay for cash and those charged borrowers.
Almost half (47%) project outperformance in healthcare as well. Current sentiment likely considers long-term profits presented by rapid development of the Covid pill, the success of mRNA vaccines, and the opportunity to pursue pre-pandemic business objectives.
The outlook on tech is also positive and 43% anticipate outperformance. As policy looks to the sector’s dominance, one-third (35%) may project breakup for big tech but most (65%) think growth for the sector will be unabated in 2022.
Outperform
Market Average
Underperform
100%
54%
30%
16%
51%
33%
16%
47%
42%
11%
43%
33%
24%
42%
43%
15%
35%
50%
16%
27%
57%
16%
27%
51%
22%
26%
54%
20%
22%
48%
30%
12%
49%
39%
100%
Markets are due for a correction
Even with a decidedly positive outlook, fund selectors see the potential for a correction in store. The key question: Which correction is most likely?
Cryptocurrencies
Bonds
Stock
Tech
The clearest correction concern among selectors is not within traditional asset classes as six in ten (62%) predict a correction for high-flying cryptocurrencies. Even with risks, clients may be paying more attention to return potential and 36% say clients are demanding a crypto offering.
Three in ten selectors think investors should have some crypto exposure in their portfolios but a number of hurdles will need to be cleared in order to fulfill demand. Eight in ten (82%) say crypto will need to be more transparent before their firm can offer investments. The same number think crypto will need better regulation. 65% think firms will need more education before they can start to invest in crypto.
2
Portfolio strategy for 2022
Rates, inflation, and valuations top risk concerns
Despite changes in economic factors that shape market assumptions, fund selectors anticipate no dramatic shifts in allocation strategy. Instead, they will rely on tactical calls within individual asset classes to balance the risk/return potential of portfolios.
2021
2022
Given that many anticipate interest rate hikes in 2022, it’s no surprise that interest rates (70%) would top their list of portfolio risks. Not only will rate increases present challenges for bond investors, but low rates have been a key driver of record equity market growth over the past decade. As a result, rate risk factors into plans for both asset classes.
Interest rates
70%
Inflation
68%
Valuations
48%
Volatility
47%
Liquidity
16%
Inflation (68%) ranks almost as high on the list of risks. Economists at first had generally seen inflation as transitory, the result of supply chain disruptions and improving employment numbers. Many now think the US is in for a more prolonged bout of inflation, with labor continuing to tighten as the unemployment rate drops to 3.5%. Wage growth has begun to accelerate, highlighted by the huge gains seen from job switchers. And still lingering supply-related issues are keeping prices elevated for key segments of the marketplace.
While making little in the way of broad changes to allocation strategy, fund selectors are making tactical moves to position themselves for the year ahead.
Equities+
Fixed Income+
Alternatives+
3
Investment solutions
Model portfolios, private equity and ESG strategies lead product agenda
Setting portfolio strategy is just one part of the job for fund selectors. As those responsible for evaluating strategies for firm platforms, they must also make strategic decisions on implementation.
In 2022, selectors will focus on model portfolios, private assets and ESG investments as they look to balance a changing investment landscape with the evolving needs and interests of clients.
Model portfolios for a more consistent investor experience
Model portfolios have emerged as a key option for firms looking to manage client expectations and risk exposures. In fact, 80% of respondents globally report their firm has some form of model portfolio offering.
Models will be a key focus for 2022 as selectors look to help end investors navigate more volatile markets. Overall, 82% say model portfolios provide a more consistent investment experience and seven in ten (69%) say models provide an extra level of due diligence.
Even more, 85% say models provide a streamlined investment approach. This can allow advisors to spend more time focused on helping clients address long-term goals. As evidence, 85% of selectors say models are a more efficient way of implementing UMAs.
Half of those who offer models say their firms will look to move clients into these portfolios in the next 12 months. This strategy is most favored in the US, where 67% of respondents say this is their firm’s goal, and more specifically in wirehouses, where three-quarters of selectors agree.
The case for model portfolios
85%
85%
82%
Firms increase third-party model portfolios
Globally, firms currently favor proprietary models, but more than one-third see their firm expanding third-party offerings in 2022, as is the case for 58% of selectors at US wirehouses.
Selectors see models as an efficient way to implement ESG and other in-demand investment strategies. Two-thirds say models make it easier to implement ESG across client portfolios, which may be one reason that 55% of selectors say there is greater need for specialty modes like ESG. Beyond ESG, selectors see a need for thematic (38%), alternative (34%), tax-managed (26%), and income (25%) portfolios.
ESG-focused models
Thematic sleeves
Alternative sleeves
Tax-managed strategies
Income portfolios
Selectors also find models offer key business benefits. With fee pressures tightening, 74% find that models offer a lower-cost option. The consistent experience that models offer clients also benefits wealth managers, as three-quarters of selectors say model portfolio programs help manage firm risk exposure.
Sectors see significant delta in private asset returns
With model portfolios at the core of the offering, many firms are looking to complement these risk-based strategies with non-correlated investments. For many, this leads to private assets, where two-thirds of selectors see a significant delta in returns.
In many instances, the move to beef up private offerings is a direct response to client demand, as half (49%) of selectors say their firm is offering more private investments in response to client interest.
Much as with models, ESG is a clear focus area for selectors as they look to expand private investments. Another 25% are looking explicitly for impact investments in private markets.
In terms of the types of deal they want to bring to clients, selectors are equally split between providing co-investment (28%) and direct investment (27%) opportunities. Given the scale of the recent wave of private investment, 25% are looking to give clients the opportunity to capitalize as funders sell out of original positions through the secondaries market.
ESG
45%
Co-investment
28%
Direct deals
27%
Impact
investments
25%
Secondaries
25%
Infrastructure tops private market sector calls
With one notable exception, sector calls for private markets echo those for public markets. Selectors make infrastructure (42%) their top private opportunity. With interest rates low, selectors may see infrastructure as an opportunity to provide a consistent source of yield. This strategy would only be enhanced by increased public investment like the $1 trillion US infrastructure bill.
Respondents also see information technology (41%) and healthcare (39%) as top private opportunities. Energy (29%) and real estate (23%) are also in favor, although US wirehouses were twice as positive (44%) on real estate as selectors globally.
Sectors may provide direction on where to look, but selectors will examine opportunities carefully. Nine in ten (90%) say due diligence is paramount when choosing deals, something 60% say has been made harder by Covid. Expenses are also in focus as two-thirds say current fees are too high based on expected returns.
Six in ten to add to ESG offerings
Investor demand for ESG has grown substantially in recent years, and wealth managers are responding. Six in ten (64%) selectors say they plan to add to their ESG offering over the next 24 months.
Though many implement ESG to align assets and values (48%), to make a better world (33%) and meet investment policy mandates (32%), selectors also see an investment rationale: Seven out of ten say ESG is integral to sound investing and 63% go so far as to say there is alpha to be found in ESG.
Despite impressive gains posted during the pandemic, only 20% believe momentum is driving demand for ESG. In fact, selectors say clients are investing to influence social and environmental issues (54%) with their investments or see an opportunity to participate in the green economy (45%). Demographics also play a role in expanding ESG offerings as 34% say increased demand is the result of the changing demographics within their client base.
ESG
integration
57%
Incorporating ESG considerations where material to risk and return in investment analysis.
Thematic
investing
53%
Investing based on trends, including social, industrial, and demographic areas.
Exclusionary
screening
48%
Avoiding securities of companies or countries on the basis of traditional moral values, standards and norms.
Best-in-class
selection
43%
Preferring companies with better or improving ESG performance relative to sector peers.
Impact
investing
43%
Investing with the intention to generate and measure social and environmental benefits alongside a financial return.
Active
ownership
35%
Entering into a dialog with companies on ESG issues and exercising both ownership rights and voice to effect change.
Firms implement wider range of ESG strategies
Firms are implementing a range of ESG strategies to meet demand. Most frequently selectors rely on integration (57%) to consider ESG factors alongside fundamental analysis. But others take a more opportunistic approach with thematic investments (53%), such as those that align with client interest in the green economy.
Half implement exclusionary screens (48%) that were the hallmark of early socially responsible investments, and another 43% use the positive screens associated with best-in-class investments. The same number use impact investments (43%). Fewer practice active ownership (35%).
DE&I becoming part of the selection process
In terms of action on ESG, many firms are focused on diversity, equity and inclusion and 24% of selectors currently make assessments as part of their selection process. Another 43% are considering how to add it to their process.
A smaller number (37%) are actively investing for impact. One-quarter measure carbon footprint (25%) with a similar number looking to lower their footprint (24%). Only a small number (13%) are now measuring portfolio temperature.
Even as they look to expand their offering, selectors see a significant roadblock to broader ESG adoption: measurement. To date, the industry and regulators have not established a single ESG standard. Seven in ten of those surveyed say standardization will make it easier to evaluate ESG investments. And that will be critical as more firms look to deliver impact.
Working past the wall of worry
Fund selectors may not see Covid as the greatest threat to economic growth in 2022, but the pandemic still raises many questions. Since the first signs of contagion, Covid has upended global supply chains, driven inflation to a 40-year high, and pushed interest rates to unsustainable lows. Yet fund selectors consider the reopening trade to be the best bet for the year ahead. The challenge comes down to how well they deliver on portfolio solutions.
READ THE EXECUTIVE OVERVIEW
The Fund Selector Outlook Executive Overview provides a summary of the report as well as the report graphics.
Download Executive Overview
4178942.1.1
Related Articles
Institutional sentiment shows 2024 to be a year filled with many uncertainties.
7 key trends defining how the smart money is looking at ESG and sustainable investing in 2023.
Vaughan Nelson’s CEO/CIO Chris Wallis explores macroeconomic trends and the impact on equities markets in his podcast series.
While market performance suggests promising conditions, the Loomis Sayles team looks forward cautiously and likely towards a late credit cycle economy.