Decision makers participating in the Natixis 2021 Institutional Outlook Survey1 see negative rates as their top portfolio risk. They’re also worried about market volatility, and faced with uncertain prospects they have gone so far as to reduce return assumptions by an average of 60 basis points.
Even as they face these significant challenges, a majority of institutional investors plan to make no change to their asset allocation strategy in 2021.
Instead of broad strategic shifts, survey results reveal that institutions are relying on two key tactics to position portfolios for negative rates: First, they’ll take credit risk over interest rate risk and emphasize investment grade corporate bonds over government securities; then, to make up for flagging yields in traditional fixed income, they’ll increase allocations to illiquid alternative investments.
Allocation Strategy Locked in Long-Term
With more than 700 central bank cuts already implemented between 2008 and early 2020,2 low interest rates have been a given for institutional strategy for more than a decade. But this only accelerated in March. With the global economy in lockdown and markets in meltdown, bankers stepped in once again and prevented the coronavirus public health crisis from igniting a new global financial crisis.
The pandemic response resulted in another 200+ rate cuts worldwide, and by July more than one-quarter of the Bloomberg Barclays Global Aggregate Index was trading with negative yields3 and more than $18 trillion4 in negative yielding debt globally. With the majority of institutions calling for GDP returning to normal no sooner than 2022, it would give reason to be cautious about a fragile economic environment.
Undeterred, institutional investors projected shifts in investment grade corporate bonds (30% increase, 51% maintain, 19% decrease) that perfectly mirror shifts in government bonds (19% increase, 51% maintain, 30% decrease). The reason they are willing to place their bets on credit is simple: Eight in ten (78%) believe that central banks are willing to backstop the markets in the event of another downturn.
Don’t Fight the Fed
After 12 years of favorable monetary policy, institutions – along with the rest of the market – appear to be addicted to stimulus. At one point, they were worried that the support might not continue. In our 2019 survey, the majority of institutions thought the long run of intervention had left central banks with little in the tank to address a new financial crisis. The lesson learned in 2020 may simply be that there’s no such thing as running out of ammunition.
The proof point came with the Corona Crash. With news of the pandemic turning bleak, the S&P Index went into a freefall that lasted from February 20 to March 23, losing more than 30%. On March 23, the Fed stepped in and the freefall came to an abrupt end. Just 33 days later, the market was out of correction territory and on to record highs by November.
While the hunger for better yields could lead to increased equity allocations, institutions are limited in just how aggressive they can be. The decision to dial into credit risk within fixed income holdings may actually come down to the habit of considering bonds to be less risky, the necessity of regulatory constraints, and their willingness to take incremental risk over the long term.
Yield. Yield. Yield.
Even as they rotate out of government bonds into investment grade corporates, the pressure is on for institutional teams to generate the income they need to meet liabilities. With little chance of finding it within the realm of traditional fixed income, institutions are turning to alternative investments to fill the void.
Overall, institutions are most likely to make their biggest allocation shifts to the alternatives bucket, but even that is only an increase of 1.2%. More important, though, is where they plan to invest the 16.7% of assets allocated to alternatives. The plan for 2021 might as well be given the code name: “All private. All the time.”
Private debt, infrastructure, and private equity all look to reap increased investment from institutions in 2021. Among those who already hold the asset classes in their portfolios, 90% intend to increase or maintain their holdings in private debt, 91% plan to do the same with infrastructure, and with private equity, the same is true for 88%.
So, while they appear willing to take on additional credit risk, institutions may see even greater benefit in taking on the liquidity risk that comes with private investments. In truth, 44% say they are concerned with liquidity risk in private assets, but their actions show that given the likelihood that a low to negative interest rate environment is likely to last a good while longer, they like the surety that comes with the lock-up.
In essence, allocating more to private assets may be seen as the opportunity to enhance performance with less risk of the big drawdowns seen in public markets. And that looks to be the linchpin in their tactical plan for 2021.
Sleep with One Eye Open
With a market view that anticipates greater market volatility, increased geopolitical risk, and the big unknown of how long it will take to vaccinate the world against the coronavirus, institutional investors are likely to sleep with one eye open for at least the first half of 2021. Our data shows that they have been waiting for the other shoe to drop for a long while (six in ten predicted another financial crisis within one to three years in last year’s survey5). So as they look at 2021, the sentiment might best be called aggressively conservative.
2 Dion Rabouin, Axios, Central banks have cut interest rates 800 times since the Great Recession. https://www.axios.com/central-banks-interest-rate-cuts-great-recession-35ddfceb-41ad-4819-9e0b-fb89fb449d4d.html41ad-4819-9e0b-fb89fb449d4d.html
3 Natixis Portfolio Consulting and Research Group
4 Bloomberg Barclays Aggregate Negative-Yielding Debt Index, December 10, 2020
5 Natixis Investment Managers 2019 Global Survey of Institutional Investors
The data shown represents the opinion of those surveyed, and may change based on market and other conditions. It should not be construed as investment advice.
This material is provided for informational purposes only and should not be construed as investment advice. The views and opinions expressed are as of December 2020 and may change based on market and other conditions. There can be no assurance that developments will transpire as forecasted, and actual results may vary.
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Private debt includes any debt held by or extended to privately held companies.
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