European institutional investors are reviewing their bond portfolios in a context of negative rates and in order to better manage volatility; there was a reduction in equity allocations, especially in more mature markets, offset by a general increase in alternative instrument allocations. These are the general findings of the Mercer European Asset Allocation Survey 2016, now in its 14th edition and which analyzed trends in the asset allocation of large institutional investors, in particular European pension funds, for total assets of over 930 billion of Euro.
With regard to Italy, for which Mercer also investigated - through a set of qualitative questions - the prospective attitude with respect to portfolio construction, investors seem to expect very weak macro-economic growth. In fact, only 36% of the sample expect bond yields to rise, against a pessimistic 29% on the matter and a 36% who do not have a precise opinion. As regards the inflation outlook, 79% of the Italian sample expects that European and US inflation will not increase in 2016. An objective pursued firmly by Central Banks. As regards the investment portfolio, 64% of the sample do not think of investing or increasing their allocation on private markets, and only 43% think of integrating investments in absolute return bond strategies into their asset allocation. These are components which, according to Mercer, instead make portfolios diversified and more robust.
The Italian market, in terms of strategic asset allocation, is still characterized by an important presence of investments in the real estate market, historically justified, and a bond composition still oriented towards domestic government bonds. The comparison with a more evolved market, basically that of northern Europe, confirms that the weight of investments on the stock market by Italian institutional investors is significantly lower.
«The Mercer survey, by virtue of the participation of large European institutional investors and the volume of portfolios analysed, in my opinion - explains Marco Valerio Morelli, CEO of Mercer Italia - can be considered among the most authoritative sources of information on the choices of these subjects, for the value of the comparison and the pan-European dimension».
By virtue of the complexity of the economic scenario, the volatility of the financial markets and the level of interest rates now at historic lows for institutional investors, great challenges arise in the field of portfolio construction and in the generation of attractive returns. To achieve their goals, investors are being challenged to move towards less familiar and more flexible asset classes and strategies. An important evidence of the research is that this change, already underway in Europe, still encounters resistance in Italy.
Luca De Biasi, head of the Investments & Retirement area of Mercer Italia highlights: «We are, in our opinion, close to another period of great volatility on the financial markets and therefore the failure to properly consider all possible investment classes or, worse, remaining tied to traditional portfolio construction schemes implicitly exposes assets to the risk of significant losses».
A conservative approach instead emerges from the intentions and forecasts expressed by the Italian sample. As mentioned, only 36% of the sample expect bond yields to rise, against 29% who do not believe this trend is possible and 36% who do not have a precise opinion on the matter. «It might seem paradoxical that such a low percentage believes a rise in already negative rates is possible. It is probable that investors consider the prospects for macro-economic growth to be very weak» sums up De Biasi.
«As regards the inflationary prospects, implicitly – comments De Biasi – the answers of the Italian sample appear contradictory with respect to the blind faith “of the market” in the ability of the Central Banks to keep the system under control».
Bonds – The survey, at the European level, confirmed the search for a wider diversification on bond portfolios. Within this category, absolute return strategies have a higher average allocation; such strategies offer diversification in an environment of potentially rising interest rates.
In general, in the context of European bond portfolios, there has been a trend away from government bonds in favor of corporate bonds, in the light of institutional investors' continued search for yield.
Emerging markets – While the flow of capital from retail investors to and from emerging markets remains volatile, allocations from European institutional investors have remained, on aggregate, broadly stable. Despite the disappointing performances recorded in recent years, emerging markets continue to represent 6% of total assets (unchanged from the previous year), of which both equity and bond stocks are common components of European institutional portfolios. “It is encouraging to see institutional investors have long-term perspectives on emerging markets, in stark contrast to the behavior of retail investors. We continue to support exposure to emerging markets as part of a well-diversified growth-oriented portfolio» comments De Biasi.
“Alternatives” segments – «Many markets are suffering crises of reduced liquidity and consequent volatility; institutional investors may want to take advantage of opportunities created by market volatility. The clear role of diversification and the attractive return profile continue to characterize the interest and topicality of these asset classes. In this context, European institutional investors show a willingness approach also towards illiquid instruments, in order to benefit from higher yields» comments De Biasi.
The research findings indicate that European investors are focusing on active management in 'alternative' segments, given the scarcity of 'beta' opportunities (passive market exposures) in the current market environment. “Mercer suggests looking for a greater contribution of alpha to portfolio returns as a way to meet the challenge of a low-yield world. In other words, to rely on the manager's skills. However – continued De Biasi – we find a considerable variability in the behavior of pension plans on the basis of their size and governance. The larger institutional investors, precisely by virtue of their size and consequently the better structuring as regards both the investment area and the Governance, resort more frequently to the use of active and flexible portfolio management».
"Even for the Italian pension fund market, we hope for an ever-improving adoption of structuring and governance practices in line with European best practices, as well as an ever-increasing awareness of the role of institutional investors for the economy of a mature country," adds Morelli. "Investments in real assets are often the subject of discussion, even of the system, both for the interesting risk/return profile and for the role that institutional investors can play in supporting growth," explains De Biasi.
ESG (Environment, Social, Governance) – Finally, the survey revealed a still growing attention to environmental, social and governance (ESG) factors within the investment processes of the participating funds. 79% of respondents in Europe reported that they consider these issues, up from almost half (55%) in 2015. Key factors cited to motivate attention to ESG issues were the potential financial impact as well as the management of the reputational risk. «Stakeholders consider socially responsible and sustainable investment issues at different levels, but especially in the manager selection and monitoring process and increasingly rely on advice to understand to what extent their managers, active or passive, incorporate these issues as part of their investment process. I would like to underline one of our beliefs: the most effective way to access sustainable investment opportunities is through investment in private markets, which allow access to unlisted companies and projects capable of bringing real benefits in the direction of an economy sustainable and with low emissions» explains De Biasi.
Unfortunately, the issue of ESG is still not adequately considered by Italian investors, who in 64% of cases do not consider the impact of climate change and the assessment of sustainability factors in the principles underlying their investment process.
Think long term – "Like Mercer, in speaking with Institutional Investors, whose horizon in liabilities is by definition long-term, we invite you to think with a long-term perspective also in investments" sums up Morelli. «In particular, Italian long-term investors should be able to capture relatively attractive returns on private markets, partly due to the illiquidity premium, and should be able to adopt often non-consensus-related investment policies to fully benefit from specific opportunities» explains De Biasi.
«A systemic and long-term approach to investment, which as mentioned also allows for an anti-cyclical perspective with respect to the market, also represents the challenge which Institutional Investors are called to in Italy in this historical moment, in which they are given the opportunity to question themselves with respect to their role in the economy of the country-system» concludes Morelli, who recalls: «precisely for this reason we have activated an Observatory on the investments of Institutional Investors with Casmef-LUISS with annual appointments».
