Investors see PE, alternatives as answer to risk management

  • Private equity is top alpha generator
  • Alternative investments will reduce risk
  • Investors worry about absent volatility

Private equity emerged as the top choice for alpha generation among institutional investors as they brace for volatility from perceived asset bubbles and interest rate hikes in 2018.

Indeed, investors are confident that increasing their exposure to alternative investments and other active investments will help meet the average return assumptions of 7.2 percent this year.

That is the upshot of the Natixis 2017 Global Survey of Institutional Investorsreleased Feb. 22. In the survey’s sixth year Natixis polled 500 institutional investors across North America, Latin America, the U.K., Continental Europe, Asia and the Middle East.

These included 258 managers of corporate and public pension funds, 100 managers of foundations and endowments, 107 insurance fund managers and 35 sovereign wealth funds, according to Dave Goodsell, executive director of Natixis Investment Managers’ Center for Investor Insight.

PE emerged as the top choice for alpha generation, the choice of 72 percent of the respondents. Hedged equity came second (44.8) percent and global macro was third with 42.2 percent.

Despite the range of portfolio risks in alternative investments, potential returns make illiquid investments worth the risk, according to three-quarters of the respondents.

“Institutions are hopeful that the illiquidity premium will pay off the risk,” Goodsell said.

The popularity of alternative investments stems in part from investor concerns about the recent near-absence of volatility and the possibility of its return. Nearly 59 percent said that investment flow into passive strategies had artificially suppressed volatility.

But the return of volatility and risk can be managed by increasing active investments, diversifying across sectors, risk budgeting and increased use of alternatives, the survey shows.

Seventy eight percent of the respondents said increased alternative investments would be effective in minimizing risk. Alternatives include managed futures, global macro, hedged equity, commodities, PE, private debt and infrastructure.

Additionally, 70 percent of the respondents said alternative investments were critical to diversifying portfolio risk, and 60 percent said exposure was essential to outperform the market.

The market’s growing complexity also has led to an increase in institutional investors seeking to outsource their investment function. Almost 44 percent of the respondents outsource their investment management. Only 41 percent of assets are given to outside managers, however, and the bulk of the assets are still handled by in-house teams.

Forty-nine percent of the respondents who outsource cited access to specialist capabilities as the primary reason, up from one-third in the 2016 survey. Twenty-two percent said they outsource their investment management function to get better risk-adjusted returns.

Action Item: Read more on the survey here