After a year of lockdowns, masks, and Zoom meetings, institutional investors overwhelmingly believe the new normal will stay in place in 2021. Only one-quarter (27%) see a return to pre-pandemic life in the next 12 months. The same sentiment comes through in their economic outlook.

When asked when GDP levels in their home country will return to pre-Covid levels, only one in five (21%) see recovery in 2021. The vast majority say it will take longer. While 44% are hopeful that recovery will be attained by 2022, three in ten (27%) think it won’t be until 2023. And 8% don’t expect it until 2024.

Whenever this happens, institutions will be watching for clear signs of recovery. Improved consumer spending (74%), improved business spending (68%) and improved productivity (67%) top the list. One factor that will not signal recovery: stock market performance (15%). For institutions this last factor would be a false positive on recovery, and eight in ten caution that too many individual investors assume a strong stock market equals a strong economy.

The uncertainty presented by the pandemic market casts a long shadow over 2021. On average, institutions report they have reduced long-term return assumptions by 60 basis points (6.3%) compared to 2019. For insurers, who are even more sensitive to the low to negative yields that prevail in today’s market, the adjustment is dramatically lower. On average they have reduced assumptions by 100 basis points (6.5% to 5.5%) from 2019 to 2020, which is a far cry from the 7.7% they assumed heading into 2017.¹

When do you expect GDP levels to return to pre-Covid values in your country?

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9^%

 

Q2 2021

12^%

 

Q4 2021

44^%

 

2022

27^%

 

2023

8^%

 

2024 and beyond

79% of institutions believe the market is underestimating the long-term impact of Covid-19 on the economy

Which of the following are most important to signaling economic recovery in your country?

74^%Improved consumer spending/sentiment

68^%Improved business spending/sentiment

67^%Productivity (i.e. low unemployment, wage growth)

15^%Stock market performance

14^%Higher inflation

7^%Low interest rates

Which long-term outcome(s) of the fiscal stimulus currently being provided by governments are most likely to occur?

Tax hikes

Increased risk of financial crisis

Decreased ability to respond to future crises

Cuts to social safety net programs

On watch for correction
The pandemic may have driven the S&P 500 into bear territory for the first time in 132 months, but it was the quickest market recovery on record, with the index returning out of correction territory in 33 days and reaching a new record high in less than 5 months.² Despite the bounce, eight in ten (79%) institutional investors worry the market underestimates the long-term impact of Covid and 44% see the potential for another correction in 2021. But concern is not limited to stocks:

• With the potential of the pandemic to force permanent changes in how and where people live, work, and shop, 41% see a correction coming in real estate.
• Four in ten (39%) worry that the technology sector, a clear winner in the pandemic market, could experience a correction in the year ahead as well.
• Almost the same number worry about a correction in cryptocurrency (39%), while a smaller number put bonds (29%) on the watch list.

Institutions are much less concerned about the potential impact of a downturn for Special Purpose Acquisition Companies (SPACs)³, private equity (19%), or private debt (18%).

With a contentious US election leaving a new administration to face a divided nation and divided Congress, political polarization intensifying around the globe, and still no agreement on Brexit after four years of trying, institutional investors see the potential for an uptick in political volatility in 2021.

Trumpism may have upset 70-plus years of geopolitical policy, but even as institutions anticipate a transition to President-Elect Joe Biden and more traditional leadership from the US, 69% believe geopolitical tensions will be on the rise in 2021 – a significant drop from the 81% who thought so before the US election in November. After witnessing protests around the world on issues ranging from racial justice to Covid restrictions, 77% believe social unrest will stay on the front burner.

Even before US President Donald Trump’s public refusal to accept election results and political upheaval that led to three Peruvian presidents in three days, 74% of institutional investors thought democracy would weaken in 2021. Eight in ten also believe the political climate suggests more populist candidates coming in the future.

Policy makers get mixed reviews for 2020
These political questions are significant in times like these, when consensus and swift policy action has been needed to ward off financial crisis. Even though initial stimulus programs proved effective, political discord has strained second efforts in some regions. Fewer than half (45%) of respondents say policy makers in their home country were effective in their pandemic response. Among the 174 surveyed after the election and vaccine announcements, only 39% replied “yes.” Regional data highlights where this split opinion comes from:

• In Asia, where policy makers acted swiftly to contain the public health and economic impact of the pandemic, 71% of respondents say policy makers were effective.
• Results are inverted where it was harder to reach consensus; 64% of respondents in North America and 71% in the UK say “no,” policy makers have not been effective.

When it comes down to it, though, institutional investors say they are more concerned with policy than politics, with 78% saying central bank policy has more of an effect on markets than elections do.

Percent of institutions that agree

Long-term risks
Policy concerns run deep. The stimulus needed to quell the economic shock of the global pandemic is a prime example of how even a necessary action can present significant long-term risks.

Globally, policy makers have provided $12 trillion in stimulus to support individuals and businesses. Now, with infection rates on the rise as winter comes to the Northern Hemisphere, more stimulus will likely be needed.

But even before policy makers make their next move, institutional investors foresee potential problems down the road: About two-thirds (65%) anticipate the spending will result in future tax increases. Another 44% believe spending will lead to future cuts to social safety net programs.

Market implications loom large as well: More than half (53%) believe pandemic spending has increased the risk of a new financial crisis. Making the worry worse, 52% say the 2020 response will limit the ability of policy makers to respond to a future crisis.

Given the uncertainty, institutions are split in their view as to which approach will work best in 2021 institutions: 53% say defensive portfolios will outperform in 2021 and 47% say an aggressive approach will yield better results. Opinions on the outcomes may be split, but institutions generally agree on where the risks and opportunities lie.

Negative interest rates top their concerns. With central bankers around the world making 205 rate cuts between January and November, and more than one-quarter of the Barclays Capital Global Aggregate Index trading with negative yields since July,⁴ it’s no wonder 53% of institutions rank negative rates their top portfolio concern. Given the critical role bonds play in insurance company portfolios, it’s no surprise that 64% of the insurers surveyed are worried about rates.

Adapting strategy to account for negative-yield securities is one of the biggest challenges facing institutions, and almost one-third (28%) say their organizations have already invested in negative-yield securities. This practical experience will help in 2021 as 53% anticipate heavier volume for negative-yielding bonds. Managing the risk should be a significant challenge, as seven in ten (71%) say institutional investors are already taking on too much risk in pursuit of yield.

Between the realities of Covid-19 and political uncertainties, 52% of institutions are also focused on volatility as a key risk. Nearly two-thirds (65%) project equity volatility to be on the rise – a 51-point spread from those who think it will be on the decline. Currency and bonds are other markets they say have the potential for greater volatility.

Institutional investors are also worried that economic declines related to the public health crisis could ultimately trigger a financial crisis, and 33% worry about the risk of a credit crunch.

Institutions are also concerned – albeit to a lesser degree – about liquidity (28%), inflation (23%) and deflation (20%). And even though they see the potential for volatility in the asset class, only 18% see currency fluctuations as a portfolio risk.

Valuations: where risk indicates opportunity
After a decade in which fundamentals didn’t seem to matter as low interest rates lifted stock prices, survey sentiment suggests that valuations may actually matter more in 2021 as almost six in ten (58%) institutions favor value investments to outperform growth investments.

Looking at the long-term run-up, 78% say current market growth is unsustainable. Even more, eight in ten (82%) say that current valuations do not reflect company fundamentals. The same number go so far as to say low rates have distorted valuations.

Given projections for increased volatility, greater dispersion and a preference for value, it adds up to a market that eight in ten (79%) institutional investors say will favor active managers in 2021. Two-thirds of institutions flat-out predict actively managed investments to outperform passive.

Their conviction is backed by action where it matters: the portfolio. Institutional investors continue to allocate more than 70% of assets to actively managed strategies. This is a slight increase over the three-year projections that institutions made in 2017.¹ At that time, they had allocated 68%, which they thought would be rounded off to 67% by 2020.

Institutions say this approach worked out for them in 2020, as two-thirds say their active investments outperformed in the first quarter downturn.

Institutions share concern about passive
On the other side of the coin, institutional investors voice significant concerns about passive investing: Seven in ten (71%) say large flows to passive exacerbate volatility. Six in ten (58%) say the widespread use of passive investments shows the market is ignoring fundamentals. Four in ten (41%) worry that the run-up in passive investing may actually put too much power in the hands of a small number of investors.

Active/Passive Allocations – 2020 Survey

Current allocations

2023 projections*

Active Investments

70^%

Active Investments

69^%

Active Investments

Passive Investments

30^%

Passive Investments

32^%

Passive Investments

*Active/Passive splits add up to 101% due to rounding

Institutional investors anticipate the sectors that outperformed in 2020 will continue to do so in 2021. Even though they share some concern for a potential correction in technology, two-thirds (66%) expect the sector to outperform in 2021, a margin 55% higher than those who say it will be down.

Institutions also see healthcare outperforming again. Despite struggles early in the year, healthcare has delivered a 9.15% gain year to date.⁵ With promising news on at least two new vaccines, 65% of institutions predicted the sector will outperform, also a 56-point margin over those anticipating underperformance.

The arrival of new streaming services and content was well-timed for a period when much of the world went into lockdown. With fewer entertainment options at hand, bingeing became the solution for many, which helped drive the communications sector to a 19.92% gain as of November.⁵ More than four in ten (42%) anticipate continued growth in 2021, or 28 points higher than those who call for underperformance (14%).

Widespread reports of panic buying and the stockpiling of home essentials like toilet paper and paper towels were a hallmark of the pandemic. As retailers posted purchase limits, the consumer staples sector ran up a 8.81% gain as of November.⁵ With second and third waves of the virus taking shape later in Q4, 32% of institutions expect the trend to continue into 2021 compared to 17% who see the sector underperforming.

Conversely, institutions see pandemic underperformance continuing in a number of sectors. With companies downsizing office space and brick-and-mortar retailers struggling, the real estate sector had posted a near-4% loss year to date.⁵ Institutions see more of the same in 2021, as 44% project underperformance from real estate, a difference of 29 points with calls for outperformance.

Energy, where demand is not anticipated to pick up to pre-pandemic levels until later in 2021, is also expected to underperform by 42% of respondents, or nearly two times higher than call for outperformance. Materials see similar results with 32% calling forecasting below-market performance. Utilities (28% underperform / 14% outperform), financials (36% underperform / 26% outperform) and industrials (25% underperform / 20% outperform) round out 2021 sector views.

Even as they predict that defensive portfolios will outperform aggressive in 2021, institutional investors do not project any dramatic shifts in their overall allocation plans. But that does not mean they will stay put with their current holdings in each asset class among those who say they invest in them.

Click asset classes to discover the institutional moves for 2021

 

Equities

Fixed Income

Alternatives

Cash

 

Increase

No Change

Decrease

Asia-Pacific Equities

32%

55%

13%

Emerging Market Equities

31%

54%

15%

European Equities

31%

46%

23%

US Equities

25%

43%

32%

Green Bonds

48%

51%

1%

Investment Grade Corporate Debt

30%

51%

19%

Securitized Debt

26%

56%

18%

Emerging Market Debt

26%

56%

18%

High Yield Corporate Debt

26%

52%

23%

Government-Related

19%

51%

30%

Private Debt

46%

45%

10%

Infrastructure

42%

50%

9%

Private Equity

38%

50%

12%

Absolute Return Strategies

27%

55%

17%

Gold/Precious Metals

27%

66%

8%

Real Estate/REITs

25%

58%

17%

Commodities

13%

75%

12%

Cash

13%

64%

22%

Equities
After a year in which the S&P 500 went from an all-time high in February to a 30% loss in March to a new high in August,² institutional investors are wary. While 43% say they are likely to maintain their current positions, 32% say they will trim US holdings. Those assets will likely go to Asia Pacific (32% to add, 55% no change), emerging market stocks⁶ (31% to add, 54% no change) and Europe (31% to add, 46% no change).

Fixed income
Despite citing credit as a portfolio risk, institutional investors are more concerned with addressing their top concern: negative interest rates. While 51% plan no changes to government debt holdings, 30% say they will trim positions. Most frequently, they plan to up investment grade corporates (30% to add, 51% no change). Securitized debt⁷ (26% to add, 56% no change), high yield corporates (26% to add, 52% no change) and emerging market debt (26% to add, 56% no change) follow.

Conviction on green bonds⁸ runs high, as among the 48% of respondents who hold the securities, 48% say they will look to increase their investments while 51% will make no change. Only 1% say they will trim their positions.

Alternatives
Among those who own them, alternative allocations appear to be the Swiss Army knife in 2021 plans: The hunt for yield is most clearly reflected as close to half (46% to add, 45% no change) say they will increase investments in private debt,⁹ while four in ten say they will add to infrastructure investments (42% to add, 50% no change). Institutions are also looking to alternatives to boost returns with private equity (38% to add, 50% no change).

In terms of risk management, institutions are most frequently upping allocations to gold and precious metals (27% to add, 66% no change) as well as absolute return strategies¹⁰ (27% to add, 55% no change).

Institutions continue to look to private markets to fulfill portfolio plans, but even as they do, many are cautious about the effect that outsized flows will have down the road. After seeing investors turn to private assets en masse in recent years, six out of ten (61%) worry that there is too much money chasing too few deals. Another 36% say the level of uninvested assets is too high.

Despite any reservations, roughly 80% of institutions invest in private assets and seven in ten respondents overall say these investments will play a more important portfolio role going forward.

To access private assets, institutions deploy a wide range of vehicles: On the equity side, institutions most frequently rely on private equity funds (65%). Infrastructure (45%) and co-investment (44%) are also popular while another 43% go the fund-of-funds route. A significant number also invest in growth capital (37%) and venture capital (36%).

Secondaries and leveraged buyouts (both 29%) appear to be less popular routes to private asset investments, as does mezzanine financing (18%).

Counter to the pooled path, institutions most frequently turn to direct lending (45%) for private debt. Infrastructure comes in second at 40%. Other vehicles include co-investment, distressed debt, and mezzanine financing (35% each), along with special situations (34%).

Projections for sector performance within private assets are concurrent with views on markets overall, with institutions saying the most attractive opportunities are to be found in healthcare (61%) and information technology (60%). But in one significant deviation from public markets, institutions place energy (25%) as a distant number three.

When asked about the issues that will win the headlines in 2021, institutional investors offer some mixed perspectives on how everything will turn out in 12 months. Some projections, like active (67%) outperforming passive (33%) or the likelihood of the economy recovering from Covid (78% no / 22% yes), are clearly defined. Others, like defensive portfolios (53%) outperforming aggressive (47%), are closer calls. Overall, they paint a picture of the Great Wide Open facing investors in the year ahead in which uncertainty, risk and opportunity will be shaped by more factors than the markets alone.

Active investing outperforms

Passive investing outperforms

Aggressive portfolios outperform

≈

Defensive portfolios outperform

Global economy fully recovers from Covid-19

Global economy cannot escape consequences of Covid-19

ESG funds outperform

ESG funds underperform

Growth stocks outperform

Value stocks outperform

Large-cap outperforms

≈

Small-cap outperforms

The Covid ‘new normal’ is here to stay

Life will revert to how things were before the pandemic

Developed markets outperform

≈

Emerging markets outperform

Big tech is broken up

Big tech continues to grow unabated

Geopolitical tensions rise

Geopolitical tensions deescalate

Democracy strengthens globally

Democracy weakens globally

Social unrest increases

Social unrest deescalates

Institutional investors look out across the possibilities in 2021 and see an uncertain mix of challenges and opportunities. Even as the S&P 500 reenters record territory, they are wary of assuming that run will continue. For every reason that makes them optimistic there is another that gives them pause. With most calling for another 12–24 months before the global economy recovers, time will be the key factor that determines how their projections pan out.

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