bfinance: Investors are refocusing their portfolios amid a global macroeconomic turnaround

14 november 2022

Independent investment consultancy bfinance has released its biennial global asset owner survey. With 2022 proving to be a year of major market and macroeconomic upheaval, the survey queried 396 senior investors, whose institutions are responsible for more than $13 trillion in assets, based in 40 countries, to see how they have fared and what they expect for the future.

In 2022, only 56% of investors are “very” or “quite” satisfied with their overall performance so far, compared to 82% in Summer 2020. However, most do not appear to be laying the blame at the door of their strategy (e.g., their strategic asset allocation): 82% are satisfied with performance there. Meanwhile, 63% are satisfied with the performance of their Active Managers with frustration particularly evident in equities (particularly Emerging Market Equities) and Emerging Market Debt.

Investment portfolios

The trend towards private markets in asset allocation remains in force, with 52% of investors expecting exposures to increase over the next 18 months. Some 28% expect to cut exposure to equities and there is a very modest positive ‘swing’ in favour of fixed income, driven both by higher interest rates and by investor de-risking. Hedge funds see no swing, despite the exceptional performance of CTAs and global macro strategies through recent turbulence, but there is an expected positive sentiment for certain hedge fund sectors as investors consider their long-term strategic diversification.

In terms of macro concerns, 87% of respondents were concerned that inflation and rising rates will impair their ability to achieve investment objectives. That being said, only 43% of investors have recently made and/or are about to make changes that increase the inflation-sensitivity of the portfolio, and just 17% expect to do so in the coming 18 months, as fears of recession loom large. Improvements in funded status and higher interest rates are supporting a modest trend towards liability-driven investing (LDI). Nearly half of investor respondents (46%) indicated that liability-driven investing was relevant to them. Within this group, 19% of investors said that they are moving further towards LDI-type approaches, versus 3% that are moving away.

Additionally, 20% of investors are predicted to shift towards active management in the next 18 months, compared to 14% moving towards passive investment. This follows 16% of investors saying that they have moved towards active management in the last 18 months, versus 13% who have moved towards passive investment - a massive contrast to 2018, where 31% of investors were shifting towards passive investment. The movement in favour of active management is most evident among insurers and endowments/foundations. Wealth managers, conversely, are trending towards passive as they seek to compete with peers on cost while simultaneously adding alternative strategies.

Additionally, only 8% of investors currently have exposure to cryptocurrencies, but this is set to rise to 21% in five years’ time. The responses differ substantially by region: 57% of US investors expect to have some exposure in five years’ time versus just 11% of those in the UK.

Illiquidity

Overall, 33% of respondents said they expect their portfolios to become less liquid over the next 18 months, versus just 12% who expect it to become more liquid. The results for insurers and endowments/foundations are even stronger (41% and 42% respectively). Illiquidity is not just a function of exposure to strategies with a lengthy formal lock-up period: equity and fixed income investments have varying and variable liquidity profiles.

To what extent are investors affected by the ‘denominator effect’, where large declines in public markets mean that private markets (which are slower to experience a downward adjustment) appear to be over-weighted in the portfolio? Some 49% say that they can “wait as long as it takes” for the dislocation between public and private strategies to unwind. The most patient cohorts were family offices and endowment / foundation / SWF investors: three in four family offices say that there is “no pressure to rebalance at all”. The other half of the investor respondents experience pressure to rebalance when there are large dislocations in public markets, either imminently (19%) or within a few quarters (32%).

It is interesting to note investors’ varying expectations around the illiquidity premium. Three quarters of the investors who use Private Equity expect it to outperform public equities in 2022 - even after correcting for measurement errors such as delayed mark-downs. Insurers appear the most confident on this point: 98% expect outperformance, though many of this cohort are relatively recent entrants to the asset class. Looking beyond 2022, the true value of private equity positions will depend heavily on investor sentiment.

ESG

ESG-related practices, including newer themes including carbon reductions and impact investing, are still on the rise. A quarter of investors are now engaged in ‘impact investing’, with a further third planning on doing so.

When it comes to carbon, 32% of investors are reducing portfolio carbon emissions/intensity. When appointing managers, investors take ESG credibility increasingly seriously, with a growing emphasis on climate and carbon. One third of respondents would now be “unlikely” to hire a manager who has not made a Net Zero commitment. Beyond the climate topic, US respondents and Family Offices are considerably more active on the subject of gender and ethnic diversity than on climate-related aspects.

Resourcing

The 2018 study evidenced a trend towards improved efficiency, with investors pushing investment costs down — even while adding complexity and alternative asset classes. The past three years, however, show no evidence that the cost-reducing trend has continued. Asset manager fees have been declining, particularly in equities and fixed income: 54% of investors say that fees for ‘like-for-like’ strategies in public equity have fallen in the past three years. Yet the report also notes a shift towards outsourcing a greater proportion of assets to external asset managers—30% have moved in this direction in the past three years. The ‘outsourcing’ trend replaces a previous (modest) trend towards manging a greater proportion of assets in-house.

Despite the rising use of external management, asset owners’ in-house teams continue to become larger and more sophisticated: 48% of investors have increased the number of investment staff in their in-house team during the last three years. This represents the continuation of a crucial trend towards improving capability: portfolios have become more complex and today’s investment climate is increasingly challenging.

Finally, with costs under scrutiny, the report finds that 21% of investors are now happy to conduct ‘virtual’ due diligence for all external managers, including new relationships – saving on travel and related costs. Smaller investors are happier than their larger counterparts to conduct virtual due diligence in all cases.

Kathryn Saklatvala, Head of Investment Content at bfinance, said: “This has been a fascinating juncture at which to carry out this biennial study. There is now no doubt that we are in a period of secular macroeconomic transition. Institutional investors are evidently concerned about inflation and rising rates, but the looming threat of recession and the steep decline in public markets this year makes the prospective choices very difficult indeed. The investment strategies that may provide the greatest resilience in a climate of inflation and rising rates may also be more vulnerable in a climate of recession and higher defaults, and vice versa. Private markets have initially appeared to provide more resilience, and investors are continuing the long-term trend to increase exposure to illiquid strategies, but complacency should be avoided at all costs. Investors must now navigate these ‘traps’ with care.”