Natixis Global Survey of
The waiting game:
By Dave Goodsell
Despite big gains for stocks and bonds during 2019, institutional investors are worried that stalled trade talks, slow global growth, and low yields could hurt portfolio performance in 2020. But the question isn’t which risk will do the damage, it’s more a question of when.
Few see an upside in trade disputes. Almost three-quarters (73%) project trade will have a negative impact on performance. And with developed markets delivering less than 2% growth, and emerging markets dropping to 4% or less, 67% of institutional investors also believe slow growth will have a negative impact on investment performance.
Even after a decade of historically low rates, six in ten institutions also believe the low yield environment will hamper investment performance in 2020. Almost the same number (58%) see the potential for asset bubbles to thwart performance.
Rising levels of public debt is also on their minds, as nine out of ten (89%) are concerned about its impact on global financial security. When it comes down to it, institutional investors (83%) say we are in for the next global financial crisis within the next five years.
But even as they see a wide range of risks for 2020, portfolio projections show institutional investors are not willing to make big bets that these concerns will be realized by markets around the world. Instead their strategy appears to be “Let’s wait and see.”
6% of institutional investors do not think there will be another global financial crisis.
- Market volatility becomes a portfolio
- Uncertain markets call for active
- Asset allocations remain in a holding
- Sector preferences reveal limited hope for
- Markets are due for a correction, but which market...and
- Politics are the elephant in the
- Central banks, interest rates and the viability of negative
- Going private to get better
- ESG takes institutions from investing for values to investing for
- Institutions worry about how individual investors will
About the survey
Institutions see volatility as a predictable outcome for markets in 2020. Overall, 77% believe stocks will be more volatile, while 62% project greater volatility for bonds. More than half (52%) also project an uptick in currency volatility.
US politics have a big influence on views about equity volatility. Many believe impeachment proceedings and the looming presidential race could both present shocks to the system. Add to it a lack of progress on the more substantive issues behind the US/China trade war and volatility concerns come more into focus.
Calls for bond volatility are more surprising since current policies leave little room for central banks to maneuver. In the past year, investors pinballed from rate hike fears to a series of cuts, resulting in volatility. But with rates now priced appropriately, the worry may be that any sudden policy shift will upend the balance.
Factors like these may be why institutions rank volatility (53%) as their top portfolio risk for 2020, but perennially low interest rates (50%) finish a close second. Respondents also worry about the impact of a credit crunch (37%) and liquidity issues (35%), while one in five are on the watch for deflation.
As a result, risk management is top of mind for institutional teams and three-quarters (74%) report they are willing to underperform the market in order to ensure downside protection.
With volatility rising, about half of institutions (46%) believe dispersion will be up, too. The resulting increased spread between security prices may be one reason why three-quarters of institutional investors say markets will favor active management in 2020. This should be welcome news to the 71% who find it harder to generate alpha as markets become more efficient.
Institutions have been building portfolios with an eye toward this market scenario, increasing allocations to active over the past three years.1 They will look to maintain their 70% active to 30% passive split over the next three years.
Active/Passive Allocations – 2016 Survey
Active/Passive Allocations – 2019 Survey
Institutions caution individual investors in their assumptions about passive investing. Many have loaded up on passive investments in recent years, and 74% think individual investors have a false sense of security about index funds.
Institutional assessments appear to be on the mark. Our 2019 investor survey shows that only 55% of individuals recognized that passive investments cost less, but 62% thought they are less risky. But institutional concerns over passive reach well beyond the individual misconceptions.
Institutions see significant risks in outsized flows into passive investments: 64% say it amplifies volatility, 54% think it shows that the market is ignoring fundamentals, while 57% worry the phenomenon has led to a concentration of shareholder control.
Even though they see challenges on the horizon, institutions aren’t planning significant allocation shifts. In fact, current allocations are within one or two percentage points of what institutions projected for 2019.
The most likely rationale for staying put is simply the direct conflict presented by an aging bull market for equities and an extended low yield environment for fixed income. With stocks in the tenth year of a bull market, and indexes delivering double-digit returns in 2019, equities look a bit expensive and risky. But the lack of a significant allocation shift suggests that they are holding steady, with hopes of capturing any additional gains simply because with bond yields so low they see no other alternative.
With bonds, falling rates have featured prominently in portfolio strategy for the better part of the decade. Even after witnessing an inverted yield curve one month and watching it return to normal the next, it appears that institutions are happy to play the hand they’ve been dealt. It appears they want to moderate overall risk exposures, which they think can do with bonds.
Alternative investment plans show slightly more movement, which reflects how far afield institutional investors are willing to go for yield replacements. Those looking to adjust alternative allocations say they will increase private debt, infrastructure and real estate holdings.
Overall, sector calls reflect the same muted performance outlook. In most cases, institutions express no distinct sector preferences for 2020. They expect market performance from most sectors with split projections for outperformance and underperformance.
Two exceptions are healthcare, where it’s likely they see long-term growth potential in aging demographics, and information technology, where the development of artificial intelligence, machine learning and quantum computing present long-term growth trends. Moderate to negative projections for materials reflect just how much they think growth has slowed.
The lack of conviction for other sectors suggests that institutional investors may be looking at low rates, slow growth, and a range of other factors and finding that it all adds up to a big “meh” on market performance.
2019 was a stand-out year for stocks, especially the S&P 500 and the EuroStoxx which both reached the rarefied air of 24% returns as of November 15. But it seems that institutional thinking lends itself to Newtonian physics. Investors believe that what goes up will inevitably come down. The question is when.
Almost half (48%) believe that equities are due for a correction in 2020. With the US in the midst of its single longest economic expansion on record, and other markets continuing to shine, it appears institutions have some concerns that prices are inflated and stocks are overvalued.
Another 46% believe cryptocurrencies are due for a correction. Crypto has been a leading candidate for a correction in our last three surveys, and the asset has weathered numerous corrections only to bounce back time and again. Institutions may be wondering which, if any, correction will stick.
Four in ten also see a correction in the wings for the IPO market. After the debacle of WeWork, and bumpy rides for both Uber and Lyft, it’s likely that institutions believe unicorn valuations have been overly optimistic and see it as time for valuations to come back to earth.
4% of institutional investors globally do not believe there will be a market correction in 2020.
From impeachment in the US, to Brexit in the UK, instability in Bolivia, and a rising tide of populism globally, there has been no shortage of political intrigue for markets to react to in recent years. Many events produced volatile short-term reactions, but few have delivered lasting impact to investors.
In 2020, institutional investors will be watching the US presidential election carefully. Overall, 64% project that the US presidential election cycle will result in market volatility. More immediately, 54% believe impeachment proceedings will have a destabilizing effect on the markets.
In terms of who wins, institutions are split on the performance outcome. Just over half (52%) think the market will respond favorably to a new US president, while 54% see an unfavorable reaction should the Democrats win both houses of Congress. Elections may present some short-term performance concerns, but policy may have a longer-lasting impact, as 73% believe trade disputes will have a negative impact on performance.
Either way, institutions are deploying three key strategies to prepare portfolios for political risk. Most frequently they are looking to scenario analysis (48%) and establishing capital buffers and reserves (47%) to manage the risks. Nearly one-third simply say they will need to be nimble and agile in their approach in 2020.
|Have capital buffers/reserves in place||47%|
|Be more nimble and agile||31%|
|Prioritize risks based on some clear criteria||25%|
|Create signposts that track risks (and show how they are changing)||22%|
Even after a decade of ultra-low rates, institutions are constantly challenged in their search for yield. The pressure to deliver is so great that two-thirds of those surveyed worry that institutional investors have taken on too much risk in pursuit of yield.
Negative yields in the European Union, Germany, Japan and elsewhere increase the challenge. More than half of institutions (56%) expect an increase in the volume of negative yielding bonds in 2020.
It may seem counterintuitive, but one-quarter (26%) of those surveyed say they have already invested in some of the $17 trillion in negative yielding bonds that have been issued worldwide. In some cases, taking on these securities is a defensive move designed to help hedge portfolios against a potential market sell-off, a time when negative bonds tend to rally.
When it comes down to it, institutional investors are concerned about the ability of central banks to manage through a new crisis. More than half (54%) worry that banks do not have the tools they need at their disposal. While it may be the biggest challenge, it’s by no means the only worry they have about central banks.
Institutions also wonder if bankers can live up to increased expectations (36%), their perceived lack of independence (35%), the lack of global coordination (34%) and bankers’ ability to gauge market reactions (29%). It all adds up to a general insecurity about what could happen next.
|Lack of tools at their disposal||54%|
|Lack of independence||35%|
|Lack of global coordination||34%|
|Gauging market reaction||29%|
Challenged to get what they need from traditional assets, institutions have turned to private markets. Overall they believe private assets are better suited than traditional assets for two critical portfolio functions: delivering diversification (62%) and generating more attractive returns (61%). This combination is in high demand, making private assets a popular choice with 79% of institutions investing in private equity and 77% in private debt.
But this popularity poses some questions for institutions. When asked about their concerns about private investments, 86% worry that there may be too much money chasing too few deals, while seven in ten eye liquidity risk and 65% wonder if the level of uninvested assets may be too high.
Despite any potential challenges, institutional investors don’t see private assets as a temporary solution. Nearly seven in ten (68%) say private investment will play a more prominent role in portfolios going forward. When it comes down to it, institutions believe the returns of private assets are worth the liquidity risk (71%) and the majority (63%) say they are worth the higher fee.
|Funds of funds||46%|
Environmental, Social and Governance investing is being more widely adopted as 64% of institutions report they implement some form of ESG in their portfolios. Even though institutions have generally been on the leading edge of the practice, this represents a nearly 10% increase over 2017 when 40% did not implement ESG.
More often than not, institutions say they do ESG to align their assets to organizational values (57%). But many also see potential investment benefits in this type of investing. More than half (54%) of institutions believe there is alpha to be found in ESG, while almost four in ten (37%) implement ESG as a way of minimizing headline risk.
Beyond investment strategy, many institutions report that, as asset owners, ESG makes good business sense. One-third (33%) of those who invest in ESG implement it as a way of influencing corporate behavior. This is further evidenced by the 57% of institutions who say they are more likely to vote in favor of ESG-related proxy issues in 2020.
But it’s not all about the numbers for all investors. A significant number of institutions (28%) say they implement ESG in order to help make the world a better place.
Institutions see risk on the horizon for 2020. They plan for it by managing expectations, shifting assets, and relying on a long-term plan. Those responding to our survey worry that individual investors are not prepared to weather the same risks.
Three-quarters of institutions believe recession worries could drive individuals to liquidate assets prematurely. In part, our respondents see that individuals are not clear on their risk/return assumptions. Nearly eight in ten (78%) say individuals do not understand their own risk tolerance, while 77% say they have unrealistic return expectations.
Natixis research bears this out, as investors across the globe expected returns of 10.7% above inflation in 2019, while 77% preferred safety over investment performance. Overly optimistic expectations and extreme caution on risk is a combination that can lead to bad decisions.
When it comes down to it, the vast majority of institutional investors (78%) believe individuals are simply too focused on short-term results.
Institutional investors have lots to worry about in 2020. But it appears they have the situation well in hand. They know politics could make markets more volatile. They know interest rates could make their hunt for yield even harder. They know global growth is likely to remain slow. But they also know it will take time, and they are patiently waiting out the market to see which trends will actually play out in the year ahead.
READ THE EXECUTIVE OVERVIEW
The 2020 Institutional Outlook Executive Overview provides a summary of the report as well as the report graphics.