By Terry Mellish
We are all aware that the major challenge affecting UK institutional investors is whether they can meet their liabilities, both now and in the future. This was confirmed by a recent survey conducted by Natixis Global Asset Management, which found that a concerning 86% of institutional investors believe their peer group as a whole is not in a position to meet their liabilities. And the problem isn’t going away: over the next three years expectations are unlikely to improve with a worrying 76% continuing to predict difficulty in funding long-term liabilities.
The question is, are we getting any closer to finding a solution?
When it comes to liability shortfall, the real root of the problem is today’s low yield environment; more than 90% of those surveyed agreed that low yields and weaker returns pose the biggest portfolio risks. With interest rates continuing to cling to all-time lows (in itself increasing the valuation of liabilities), bonds are unable to provide sufficient returns and even if they do rise investors face the potential risk of capital losses from their holdings.
In addition to this, markets are being increasingly dominated by global event risk, resulting in on-going volatility and a rise in correlations across asset classes.
This new market environment has highlighted how the traditional approach to asset allocation has become outdated and a broader attitude to diversification is needed; 83% of institutional investors advocate the need to replace traditional diversification and portfolio construction techniques with new approaches to achieve results.
So with a consensus reached, what can be done to address the issue?
With regard to closing the yield gap, alternatives can play a key role in delivering new streams of income. What’s more by adding alternatives to their asset allocation mix, institutional investors can build more durable portfolios that diversify risk, as these investments are uncorrelated to the broader market; this trend is certainly catching on with 65% of institutional investors from our survey confirming they would be doing this in the next 12 months. While this asset class is not new in itself, what is different is the broader approach being taken to alternatives investments. New real estate investment solutions, such as real return and real estate alternatives funds, infrastructure and private equity are proving popular with investors: 43% will increase their allocations to real estate, 30% will increase their private equity holdings and, in a welcome response to government initiatives to encourage greater infrastructure spend, 46% expect to add to their infrastructure-related investments.
As for market volatility, investors can navigate this successfully by building more durable portfolios that make smarter use of traditional asset classes and incorporate better risk budgeting techniques. High conviction, concentrated equity and fixed income strategies that provide more diversification are often more attractive solutions, enabling them to generate superior returns at appropriate levels of risk. Appetite for such an approach is clear, with the survey finding 76% of institutional investors intending to add strategies, such as these, to their portfolios over the next 12 months and 70% of investors using absolute return strategies over the same period.
Asset allocation attitudes are changing, with institutional investors embracing new investment approaches that can help them meet their liabilities. However, it is important to stress that building more durable portfolios, which replace traditional asset allocation techniques, is a long-term commitment, to ensure liabilities can be met for years to come. With 84% of institutional investors believing that the average UK saver will not have enough assets to meet their financial obligations when they retire, it is important that one thing individuals don’t have to worry about is their pension being paid.
Terry Mellish is head of UK/Ireland business at Natixis Global Asset Management
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