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Institutional investors cautiously optimistic about the future

A new Fidelity survey finds that some managers are making changes to asset allocation, while many others are taking a wait-and-see approach.


Date: January 3, 2017

Retail investors aren’t the only ones feeling uncertain about the year ahead. A new Fidelity Institutional Asset Management survey found that institutional investors will be allocating more to cash and alternative investments, and less to stocks, in the year ahead. Why? Because no one’s sure what 2017 has in store.

Out of the 933 institutional investors who were surveyed, 72 per cent said they planned to increase the number of illiquid alternatives, such as private equity, in their portfolios. Almost two-thirds said they planned to increase domestic fixed income, while 55 per cent said they planned to increase cash. That’s a big change from 2012, when just 13 per cent had expected to increase their cash weighting.

As for equities, 33 per cent said they were going to decrease the amount of Canadian stock in their portfolios, while 29 per cent said they would increase it.

It’s a slightly different story in the United States, where many organizations are taking a wait-and-see approach, according to the survey. Only 28 per cent of investors plan on increasing their stock allocation in 2017 – down from 51 per cent in 2012 – while only 11 per cent plan on increasing it. The rest, it seems, are staying put for now.

#x201C;With 2017 just around the corner, the asset-allocation outlook for global institutional investors appears to be driven largely by the local economic realities and political uncertainties in which they’re operating,” says Scott Couto, President of Fidelity Institutional Asset Management. “The United States just saw its first rate hike in 12 months, which helps to explain why many in the country are hitting the pause button when it comes to changing their asset allocations.”

The survey found that institutional investors are paying more attention to their portfolios and making more investment decisions now than they did a few years ago, with an average of 12 asset allocation changes or manager hirings and firings per year.

Hiring proven managers is key

In today’s lower-returning world, companies want to hire managers who have a strong track record of investment performance. Other factors, like thought leadership, are much less important, with only nine per cent of respondents saying it factors into who they hire. On the other hand, 28 per cent said investment performance is key, 27 per cent said the investment team is critical, and 17 percent said investment philosophy and process strongly influence hiring decisions.

However, the results also show that firms might not be giving managers enough time to show their worth. Respondents said that managers usually need about two and a half to four years to demonstrate their skill, but when asked how long it took to evaluate a prospective asset manager, their answer was a year less than that. A strong focus on performance but short evaluation periods could lead to high turnover, suggests the study.

External factors impact investment decisions

In America, only 11 per cent of institutions have changed their investment process over the last three years. In Europe and Asia, though, almost half the firms surveyed said that they have altered their approach, adding more quantitative and qualitative variables to their decision-making processes.

The study also found that external factors often come into play around investment decision-making. For example, 90 per cent of respondents said board member emotions had some impact on asset allocation decisions, while 94 per cent said board dynamics and 86 per cent said press coverage also influence decisions.

Generally, though, investors are faced with an “overwhelming amount of data” when making asset allocation decisions, says Mr. Couto. “Institutional investors often assess quantitative factors such as performance when making investment recommendations, while also managing external dynamics such as the board, peers and industry news,” he says.

A more disciplined investment process might lead to “more efficient, effective and repeatable portfolio outcomes,” he adds.

Several risks could impact returns

While many risks can impact short-term performance, institutional investors are more concerned about long-term issues, and their biggest worries are around low returns, market volatility and the ability to manage portfolio risk.

“As the geopolitical and market environments evolve, institutional investors are increasingly expressing concern about how market returns and volatility will impact their portfolios,” says Derek Young, Vice-Chairman of Fidelity Institutional Asset Management and President of Fidelity Global Asset Allocation. “Expectations that strengthening economies would build enough momentum to support high interest rates and diminished volatility have not borne out, particularly in emerging Asia and Europe.”

Still, there is confidence among these institutions, which in total represent $21 trillion in assets. On average, they are targeting a six per cent annual return, but expect to achieve two per cent in excess returns every year. Half of that excess, they say, will come from shorter-term factors, like an individual manager’s performance and strategic asset allocation.

“These institutional investors understand that taking on more risk, including moving away from public markets, is just one of many ways that can help them achieve their return objectives,” says Mr. Young.

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