Since the emergence of “Modern Portfolio Theory” and the “Capital Asset Pricing Model” in the late 1960s, institutional investors have taken a quantitatively driven approach to portfolio construction, looking to create portfolio diversification and obtain better risk-adjusted returns by balancing their asset-class exposures. This journey has seen several important advancements in thinking about how to optimally achieve desired results.
Funds that want to take the total portfolio approach first need to get the total portfolio view. To do that they not only need data – and lots of it – but a rock-solid understanding of exactly how they’re going to use it.
Instos shun liquidity in private markets push
Bfinance surveyed 396 “senior investors” across 40 countries at institutions with combined assets under management of $13 trillion. And around half of the global respondents (52 per cent) said they expected to increase their exposure to private markets over the next 12 months – 43 per cent of Australian respondents were prepared to do the same – while 33 per cent of respondents expected their portfolios to become less liquid over the next 18 months.
A potentially problematic finding that arises from this one is that 49 per cent of respondents say they feel no pressure to rebalance portfolios when public market dislocations and the ensuing denominator effect throw them out of whack, and feel that they can “wait as long as it takes for the dislocation between public and private strategies to unwind”.
“The slump in equity and fixed income markets in 2022 has left many investors with higher exposures to private market strategies,” The bfinance report says. “Even if investors do ultimately anticipate that private markets will fall into line with public markets, this does not mean that they can “wait as long as it takes”.”
“A steep temporary decline in overall liquidity can become problematic where investors need to meet margin calls, fund commitments or handle other cashflow demands. The recent pressures faced by UK corporate pension funds are a useful cautionary tale in this regard raising questions around discipline.”
Family offices and sovereign wealth funds were the most patient respondents, willing to twiddle their thumbs with no pressure to rebalance. But 44 per cent of pension funds were happy to do the same. The majority of Australian respondents “follow discipline” when it comes to rebalancing private market exposures, while 71 per cent of US respondents said they could “wait as long as it takes”.
“The denominator effect has caused an overallocation to illiquid alternative assets,” said one respondent from a Canadian pension fund. “But expect the portfolio to become more liquid in the next 18 months, with a correction in private market valuations exceeding the public markets loss.”
Respondents were also extremely confident that private equity would continue to outperform public markets in 2022, “even after correcting for measurement errors such as delayed mark-downs”.
“For Australian investors, there is strong level of satisfaction towards private market strategies and their performance,” said Sebastian Mays, business development director at bfinance (photo at top). “Particularly for institutional investors, the low volatility of private assets can be extremely important both from an asset allocation viewpoint but also from a Your Future Your Super benchmark point of view.”
“Another interesting difference between Australia and global peers within the survey is the underweighting towards risk assets. During the current period 52 per cent of Australian investors are currently underweight risk assets, compared to 28 per cent of their global peers.”
On the wider investment front, some 28 per cent of respondents expect to cut their exposure to equities, and there is a “very modest” swing in favour of fixed income, driven by higher rates and de-risking. Hedge funds saw no swing, despite the “exceptional performance” of CTAs and global macro strategies through the recent market turbulence. Still, there is an expected positive sentiment for certain hedge fund sectors as investors consider their long-term strategic diversification.
“Additionally, 20 per cent of investors are predicted to shift towards active management in the next 18 months, compared to 14 per cent moving towards passive investment,” the report says. “This follows 16 per cent of investors saying that they have moved towards active management in the last 18 months, versus 13 per cent who have moved towards passive investment – a massive contrast to 2018, where 31 per cent of investors were shifting towards passive investment.”
