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.

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.

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?

• They look at the potential for rising rates and half (49%) project a correction in bonds.
• They see annualized returns of 29.57% for the S&P since March of 2020⁴ and 46% sense a potential correction for stocks.
• After seeing tech near the top of the market for the better part of a decade, 43% worry the trend has run its course and the sector will experience a correction.

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.

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.

See where fund selectors are headed

 

Equities+

Fixed Income+

Alternatives+

 

Increase

No Change

Decrease

US equities

28%

41%

31%

European equities

40%

46%

15%

Asia-Pacific equities

39%

46%

15%

Emerging market equities

39%

39%

21%

Government-related

16%

46%

39%

Securitized debt

19%

62%

19%

Investment grade corporate debt

28%

50%

23%

High yield corporate debt

32%

44%

24%

Emerging market debt

26%

48%

26%

Green bonds

50%

42%

8%

Real estate/REITs

30%

57%

13%

Absolute return strategies

39%

53%

7%

Private equity

45%

47%

8%

Private debt

35%

55%

10%

Commodities

26%

59%

15%

Gold/Precious metals

24%

59%

17%

Infrastructure

45%

47%

8%

Other

14%

86%

0%

Cryptocurrency

32%

57%

12%

Cash

14%

70%

16%

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^%

say they’re a more efficient way of implementing unified managed accounts

85^%

believe they offer a more streamlined approach

82^%

find they give clients a more consistent investment experience

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.

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.

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.

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.

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.

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