While some investors may have been surprised by turbulent markets at the start of 2018, professional fund buyers have been expecting a spike in volatility for quite some time. Almost eight in ten (78%) said they have been surprised that volatility had remained so low for so long and nearly half of them (49%) cited asset price volatility spikes as one of their top concerns for 2018. However, they are split on the impact volatility has on their portfolios, with 39% who see increasing volatility as a threat, while 38% anticipate a positive effect on portfolio performance. Among the other main findings of the study: professional fund buyers are turning to active management and as 78% of individual investors worldwide want their investments to align with their personal values, professionals are starting to see as much alpha benefit as risk management in ESG investments.

Natixis Investment Managers surveyed 200 professional fund buyers—responsible for selecting funds included on private bank, insurance, fund of fund, and other retail platforms.

Matthew Shafer, Head of Global Wholesale at Natixis Investment Managers commented, “The split in opinion over the impact volatility will have can be interpreted in two ways. The downside opinion is likely built on the view that after a long period of steady growth, we are due for a correction that will bring security prices back down to earth. However, on the upside, increasing volatility could signal higher return dispersions and greater potential to generate alpha. Interestingly, whatever the interpretation may be, overall professional fund buyers are turning to active management to diversify their portfolios, mitigate risk and enhance return”.

Evolving portfolio strategies to the new reality

They may be split over the impact of volatility on portfolios but more than eight in ten (82%) of professional fund buyers are confident that their average return target of 8.4% in 2018 is realistically achievable, as they evolve investment strategies to meet the new market reality. The most popular strategies for managing risk include diversifying by sector (91%), risk budgeting (80%) and increasing the use of alternatives (75%), among the professional investor community. Two in five portfolio professionals (42%) say they will manage duration to mitigate principal losses in bond portfolios. However, three in five (62%) say that fixed income no longer provides its traditional risk management role, with 20% increasing the use of alternative investments and 18% reducing fixed income exposure overall.

Matthew Shafer said, “The survey results suggest that professional fund buyers are more likely to make directional shifts in where they invest, rather than wholesale allocation changes. In fixed income they will look to shorten duration on bonds and implement alternatives to enhance income. In equities we’re seeing a preference for European and emerging market stocks. With alternative investments, they turn to private equity to generate alpha and manage volatility with hedged equity and managed futures. They see the long-term value that can be generated by active management and they implement it through a broad range of strategies.”

ESG: a different kind of value investing

As they look to deliver on the expectations of end investors, professional fund buyers have an opportunity to incorporate ESG (Environmental, Social, and Governance) investments that will help meet the preferences of the 78% of individual investors worldwide who say they want their investments to align with their personal values and the 72% who say they want their investments to do social good.1 However, fund buyers are reporting that ESG may not be getting the recognition it deserves, just four in ten (40%) surveyed say ESG is incorporated in their firms’ investment process. Some of the perceived barriers keeping them from implementing ESG are the lack of transparency (42%), conflicts between short-term returns and long-term sustainability goals, and potential green-washing by companies selling investments as ESG that do not meet the standards they are claiming (37%).

“These findings are striking and cannot be ignored. The industry as a whole must be vigilant about greenwashing and make sure that investors are getting the underlying investments and impacts that ESG products are claiming. So called responsible investing products are now numerous, that’s why we need more transparency, standards and labels. This will help to provide investors with the information they need and the sustainable products they want, the ones truly following ESG principles, meeting clear standards and measuring impact”, explains Matthew Shafer.

“We clearly hear from investors that they are concerned about issues that go beyond the balance sheet, they want to own companies that reflect their beliefs. This is particularly important at a time when ESG is at the inflection point where investors starting to see as much alpha benefit as risk management. Indeed, a majority of institutional investors (59%/45% of fund buyers agree) believe there is alpha to be found in ESG and 56% (45% of fund buyers agree) believe ESG investing mitigates risks”.

Implementing alternative investments

Professional fund buyers are increasingly looking to diversify portfolio risk and 70% believe it is essential to invest in alternatives to do so:

• More than three in five (65%) believe that traditional asset classes are too closely correlated to provide distinctive sources of return
• A range of alternatives can help with broader portfolio diversification, with 52% highlighting managed futures, almost half (47%) commodities, 44% global macro, 43% infrastructure and 38% private equity.
• In anticipation of increased volatility, half (51%) of those surveyed see the potential of hedged equity strategies to absorb market shocks while 36% say managed futures are well suited to an increasing volatile market environment

However, alternatives are not only being employed to help diversify portfolios. Over a third of professional fund buyers see alternative investments as an effective strategy for generating alpha:

• Almost three in five (58%) report that their organization is increasingly using alternatives as a replacement for fixed income, with a clear preference for real estate (52%) to generate income
• Four in ten believe infrastructure is well suited to addressing income objectives, while more than a third (35%) see private debt as an effective income generation vehicle
• Over half (58%) identified private equity as an effective strategy to generate stronger returns, with a third (31%) also highlighting private debt

“Professional fund buyers are facing a range of portfolio objectives that are made challenging by the current market environment. Whether they’re looking to generate income in a low yield environment, obtain alpha while correlations are high, minimize the effects of volatility or enhance overall diversification, professional investors favour active management and expand their capabilities with alternative investments”, commented Matthew Shafer.