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Institutions grapple with gloomy new investment order
In a world where the fundamentals of long-term market dynamics have “lost relevancy”, institutional investors are pondering a wall of worry – and having trouble figuring out how to climb it.
A survey of the world’s largest institutional investors at a time like this will deliver some gloomy responses. Indeed, many investment officers seem to be holding to their heads in their hands and trying to figure out where it all went wrong – and whether it can be fixed.
Nuveen’s survey of some 800 global institutional investors with more than $500 million in FUM reveals that many are concerned that the fundamentals of long-term market dynamics have “increasingly lost their relevancy”; that extreme and unpredictable events will disrupt their carefully planned investment strategies; and that today, “more than ever”, there is a greater need for investors to re-think how they approach portfolio construction.
“As plan sponsors and asset allocators, we’re tasked with achieving these lofty return expectations, north of 7 per cent, all within the parameters of prudent risk management. Those two things are becoming incongruent,” said one US public pension investment officer. “… It’s challenging conventional wisdom, for sure.”
But while the majority of investors will step up their inflation risk mitigation, they’re almost completely split on what to do about everything else. Roughly half of investors will increase market risk, while the other half will decrease it; the same holds true for credit quality and liquidity risk. Interestingly, several regions and investor types have more pronounced views towards non-inflation risk; 43 per cent of German and Nordic investors will take on more credit quality risk, while 48 per cent of North American investors plan to increase liquidity risk.
One area where everybody seems to be in agreement is alternatives. It’s become orthodoxy that public market returns will be muted going forward, and a vast number of institutions are now increasing their allocation to real estate and private equity to make up the shortfall. One area that’s seen an uptick in interest since Nuveen carried out its inaugural survey is private credit, with some 72 per cent of institutions now investing in the asset class compared to 62 per cent just a year ago – the largest year on year increase of any alternative asset class in the survey.
“Once upon a time, sovereign bonds used to be classed as risk-free return. I now class them as return-free risk,” said one super fund CIO. “We are holding less in sovereign bonds and less in high-quality debt, and we are looking at credit alternatives, such as emerging market debt and private credit.”
But what they’re really worried about seems to be climate. There’s a recognition here that navigating the transition to a low carbon economy necessitates playing “both defence and offense”; protecting portfolios from stranded assets and the more expensive energy prices from cleaner sources, while investing in new technologies and green infrastructure. Around 79 per cent of respondents were addressing climate risk in portfolios, and 90 per cent plan to do so in the next two years.
“The next frontier, or the next big thing in ESG, is that we are going to stop talking about the three letters ESG,” another super fund CIO said. “We will mainline all the things that are good in ESG into the investment process. Instead of having a bunch of ESG people over here and a bunch of investment people over there, we will see ESG as a good thing to do all the time.”
