BOSTON, December 8, 2021 – Institutional investors are heading confidently into 2022, armed with tactical allocation moves to counter their expectation of rising rates, lingering inflation and higher stock and bond market volatility, according to survey findings published today by Natixis Investment Managers (Natixis IM). Despite the threat of supply chain disruptions and ongoing COVID-19 concerns, institutional investors see plenty of growth potential in a market they say is driven and distorted by fiscal and monetary policies and which could spell trouble for unprepared individual investors.
Natixis IM surveyed 500 institutional investors who collectively manage $13.2 trillion in assets for public and private pensions, insurers, foundations, endowments and sovereign wealth funds around the world. The global survey included responses from nearly 100 institutional investors in the United States, who collectively manage $1.3 trillion in assets.
The consensus among the majority of institutional investors around the world is that next year’s market-driven headlines most likely will be:
- The reopening trade (travel, restaurants, return-to-the-office) outperforms the stay-at-home trade (streaming services, online shopping, remote work collaboration)
- Small caps outperform large caps
- Value stocks outperform growth
- Emerging markets outperform developed markets
- Big tech will continue to grow unabated
- Funds strong on environment, social and governance (ESG) outperform those that aren’t
- Actively managed funds outperform passive investments
Inflation ranks as institutional investors’ top portfolio risk concern in 2022 though most (61%) think the current spike in inflation is temporary. In the US, a greater number of institutions (61%) see inflation as a more of a secular trend that will play out gradually over time. The presence of real inflation for the first time in over a decade, coupled with expectations by 48% of institutional investors of a full economic recovery from COVID disruptions next year, may explain why 73% of institutions, including 83% in the US, expect policymakers to raise rates in 2022.
“Institutional investors are clearly telling us they expect the market to look very different next year than what it does today, and they are positioning their portfolios to withstand whatever is thrown at them,” said Liana Magner, Natixis IM Executive Vice President and Head of Retirement and Institutional in the US. “While inflation poses a number of long-range economic issues, interest rate policy presents institutional teams with immediate investment challenges. The upside is an expansion of investment opportunities and emerging growth potential in a market ripe for active management.”
Year-Ahead Portfolio Positioning and Tactical Asset Allocation Moves
Few institutional investors are making dramatic allocation changes heading into the New Year; however, most will make tactical moves that reflect the new realities of living and prospering in the COVID era and to position portfolios for opportunistic and risk-adjusted returns. Nearly half (48%) expect the spread between security returns, or dispersion, to widen next year, creating greater potential to outperform benchmarks.
Overall, 35% of institutions plan to decrease their exposure to US equities, allocating more to emerging market, European and Asia-Pacific stocks. As rates normalize, 68% of institutions say they will look at short-term bonds and ETFs to counter duration risk in their bond portfolio. Meanwhile, many are looking further afield for income, including 68% who say they are increasingly using alternative strategies over fixed income to generate yield.
Currently, 84% of institutions are investing in private equity, 81% in private debt and 81% in infrastructure. Of those, 91% plan to maintain or increase their investments in private equity and private debt next year, while 97% say the same for infrastructure investments. Recent passage of the Infrastructure and the JOBS Act in the US and other global actions appear to have boosted institutional investors’ confidence in both infrastructure investments and green bonds.
New Realities and Emerging Trends
While 42% of institutional investors expect COVID variants, such as the new Omicron strain, will continue to be a disruptive force in 2022, 58% think the more likely scenario is that much of life will revert to how things were before the pandemic.
The survey found:
- 62% of institutional investors expect pent-up demand for big-ticket items to be a significant driver of growth in 2022
- 41% overall, and 52% in the US, expect consumers to spend more next year, and 22% see high levels of “revenge spending” as people splurge after a long period of isolation and restrictions
- 85% expect the majority of employers to move forward with a hybrid work model, pointing to a broad return to the office for many workers
- 84% think that major supply chain disruptions would greatly hinder the pace of economic growth
- Far fewer (48%) think new SARS-CoV-2 variants would slow the economic recovery, a reflection that the world may be learning to live with COVID as an endemic.
In light of their outlook, stock sectors predicted most likely to outperform are: Energy, healthcare, information technology, financials and consumer discretionary. The most attractive private equity investments are in information technology, healthcare, and infrastructure.
Red Flags for Individual Investors
In the year ahead, institutional investors expect higher volatility in stocks (75%), bonds (63%) and currencies (56%). Yet, they continue to manage toward a long-term return assumption of 7%, on average, and with an eye on balancing present needs with future liabilities. Individual investors’ long-term return assumptions, however, are now 14.5%1, twice that of institutional investors and 174% more than the 5.3%2 returns financial professionals think is realistic.
“Institutions are prepared to navigate a wide range of risks and individual investors may want to take note,” said Dave Goodsell, Executive Director, Natixis IM Center for Investor Insight. “In many cases, they ignored the fundamentals of investing yet still managed to do well for this year. 2022 may not be as kind, especially if investors have taken on too much risk, or are overly reliant on passive, index funds. They may want to take a cue from some of the largest, most sophisticated investors in the world, who call for active management, disciplined rebalancing and a block and tactical approach to portfolio positioning to be successful next year.”
The consensus among 78% of institutional investors is that, since the pandemic began, individual investors have been more carelessly engaging in speculative, high-risk investments. Moreover, they see the top portfolio risks next year – inflation, interest rates, valuations and volatility – driven by fiscal and monetary policies that could come back to bite individual investors. For example, many think the fiscal stimulus currently provided by government will lead to tax hikes (58%), unchecked inflation (37%) and possibly even stagflation (31%). Nearly half (49%) believe the heightened level of government spending has increased the overall risk of a future financial crisis.
Despite record market highs, few institutional investors (13%) see stock market performance as a good indicator of economic health. Moreover, the survey found:
- 81% of institutional investors think low interest rates have distorted valuations
- 71% believe current valuations don’t reflect company fundamentals, so much so that 21% think valuations don’t even matter anymore
- 71% say the stock market’s current rate of growth is unsustainable, and nearly as many (68%) predict the bull market will come to an end once central banks stop printing money
Many institutional investors (58%) believe one reason the market is ignoring fundamentals is because of the widespread use of passive investments, which 67% say exacerbates market volatility when there are large flows into and out of passive index funds. Half (51%) believe the popularity of passive investments has further distorted relative stock prices and risk-return trade-offs.
Nearly two-thirds (64%) of institutional investors also believe that easier access to trading could ultimately threaten the retirement and financial security of many retail investors. Six in ten (62%) predict the meme stock phenomenon will continue to create risky financial bubbles. They think the top contender for a major correction next year will be cryptocurrencies, which 72% of institutions believe are not an appropriate investment for most retail investors anyway.
Still, 41% of institutional investors now recognize digital or cryptocurrencies as a legitimate investment option, though most (87%) agree that central banks eventually will need to regulate them.
