Institutional investors around the globe say market volatility is here to stay according to a NGAM survey

The study was based on telephone and online surveys conducted by OnResearch in June-July, 2012. Institutional investors surveyed manage/oversee corporate pensions; public/government pensions; funds of funds; sovereign wealth funds; insurance reserves/liabilities and/or endowments/foundations. The median asset level managed by the survey respondents was approximately $23 billion. Survey respondents were based in 13 countries in Asia, Europe and the Middle East, as well as the U.K. and the U.S.

Institutional investors around the globe say market volatility is here to stay and that they must use the lessons learned in the past five years to manage their portfolios.

• Eight in 10 (80%) global institutional investors say market volatility is here to stay and a similar proportion (84%) believe that volatility creates investment opportunities.
• The vast majority (81%) of global institutional investors say they find it difficult to mitigate the impact of market volatility on their portfolios.
• On a global basis, three in four (74%) institutional investors find it difficult to adhere to asset allocation targets during periods of market volatility; one-third (32%) say they cannot effectively manage portfolio risk because of unpredictable market volatility. Only 22% of institutional investors in the U.S. claim say they cannot effectively manage portfolio risk because of unpredictable market volatility.
• The No. 1 investment priority over the next 12 months selected by institutional investors across the globe is to use strategies that limit exposure to market volatility (15%); a full 31% of institutional investors in the UK say it is their top investment priority.

The lessons apply both to asset correlations…

• Just 31% of respondents say they had above-average success in the past five years in constructing portfolios that reduced correlation among assets. In the U.S. 41% of investors say they have had that high level of success; in the Middle East, only 19% say the same.
• More than half of global institutional investors (53%) say traditional assets are too highly correlated to provide distinctive sources of return. This is more likely to be believed in the Middle East (65%) and the U.K. (67%). However, 91% of investors worldwide say increasing allocations to non-correlated assets is the best way to temper volatility.

… and risk.

• Three in 10 (31%) report that their risk tolerance is lower today than five years ago, compared to 28% who say their risk tolerance is higher.
• Almost three-quarters (74%) of investors say they have changed their approach to risk management in the past five years, and a similar proportion (70%) are more confident that their current approach to risk management is right for volatile markets. In the Middle East, 81% say they are more confident with their current approach.
• Increasing allocations to non-correlated assets is viewed by 91% of institutional investors as an effective portfolio risk management strategy; so, too, is risk budgeting (90%); increasing allocations to fixed income (84%); increasing allocations to global equities (79%); and currency hedging (76%).
• Investors take numerous steps to manage risk on a daily or weekly/monthly basis. More than three-quarters of institutional investors (78%) say they examine short-term correlations to global stock indices (such as the Standard & Poor’s 500) on a daily or weekly/monthly basis; 79% consider which investments are designed specifically to produce a low correlation to the broader markets.

The majority of global institutional investors say many of the old rules of investing do not apply to current markets. The financial crisis of 2008-2009 has changed the way they look at investing.

• More than two-thirds of respondents (67%) agree that institutional investors need to replace traditional diversification and portfolio construction techniques with new approaches to achieve results. In the United Kingdom, 80% of investors agree on the need for new approaches.
• Most (65%) global institutional investors say static 60/40 policy portfolios are no longer the best way to pursue return and manage investment risk; 80% of U.K. respondents agree with the statement.
• More than half (57%) say that historical data demonstrating that longer holding periods decreases the likelihood of a negative annualized return are no longer valid.
• One-third (33%) of global institutional investors rate their institution’s capabilities as above average for removing the guesswork in managing risk during periods of volatility; another 56% say they have average capabilities. In the Middle East, 45% of investors say their institution’s capabilities are above average.

Global economic and political policies weigh on investment decisions of global institutional investors.

• Three in 10 (30%) global institutional investors predict the No. 1 source of market volatility over the next two years will be contagion from the European debt crisis, 53% of institutional investors in the U.K. make the same prediction. On a global basis, other top sources of market volatility cited include an uneven global economic recovery (16%), and political/regulatory gridlock in responding to sovereign debt levels (13%).
• Half (50%) of global institutional investors say a contagion resulting from the European debt crisis is one of the top three issues keeping them awake at night as they think about their investment objectives. One-third (33%) say regulatory uncertainty leads to sleepless nights, while 31% point to discovering unexpected sources of risk in their portfolio and 30% say it’s the inability to react quickly to volatile market conditions.
• Rising energy/fuel prices was selected by 16% of institutional investors in the Middle East as the top source of volatility in the next two years, compared to only 9% on a global basis.
• Thirteen percent of institutional investors in the UK selected a hard landing for the economy in China as the No. 1 source of market volatility in the next two years, compared to 4% of Asian investors and 6% of institutional investors on a global basis.
• The top economic issue cited by global institutional investors as having a significant influence on investment decisions is the European financial crisis (56%); 73% of investors in the U.K. and 50% in the US., agree. On a global basis, other top economic issues include economic growth (54%), central bank and monetary policy (45%) and government debt levels (42%).
• One in four (25%) global institutional investors say that unemployment has a significant influence on investment decisions, compared to 31% in the US, 20% in Asia and 19% in the Middle East.
• Global fiscal imbalance is cited as the greatest risk to their institution’s investment objectives by 15% of institutional investors on a global basis, including 32% in the Middle East. Other top risks to achieving investment objectives are global equity market risk (14%), changes in tax policies or regulations/laws (11%), change in the stability/liquidly of counter-parties (10%) and geopolitical risk (9%) .

Institutional investors find the consequences of global regulatory reform worrisome.

• The vast majority (85%) of institutional investors in Europe, including the U.K., agree that the regulations imposed by the Alternative Investment Fund Managers Directive (AIFMD) will affect fund managers negatively due to their broad scope.
• Nearly nine in 10 (86%) institutional investors in Asia along with 76% of investors in Europe agree that the staggered pace of implementing financial reform around the world (e.g. the U.S., Europe, Hong Kong) is creating more, not less, systemic risk. Investors in the Middle East were less concerned, with only 68% in agreement.
• Nearly half (47%) of institutional investors in the U.K. disagree with the statement that the most significant unintended consequence of global financial regulatory reform will be less, not more, transparency on correlated credit/equity exposures, counterparty risk, etc., compared to institutional investors in the rest of Europe (19%), Asia (20%) and the Middle East (36%).

Institutional investors are looking beyond traditional approaches to improve performance and lower risk over the long term.

• Seven in 10 (69%) institutional investors believe it is essential to invest in alternative investments – such as hedge funds, private equity or venture capital – to diversify portfolio risk. A similar percentage (63%) believes it is essential to invest in alternative assets to outperform the broad market. U.S. investors (with 73% in agreement) are most likely to say alternatives are necessary to beat market returns.
• Among respondents who use alternative assets, 85% say they are pleased with the performance of those holdings, compared with 15% who are disappointed.
• Twice as many investors (24%) who use alternatives would increase their allocation to those assets classes as would decrease it (12%) if they had to do it all again; 64% would keep their allocation the same. U.K. investors, at 44%, are the most likely to say they would raise their allocation to alternative investments.
• In a show of confidence, 61% of investors say the alternative strategies they invest in will outperform last year’s returns. Some 71% of Middle East investors expect better returns.
• Almost nine in 10 (89%) investors say increasing the use of liquid (more unconstrained) alternatives such as global macro or long/short equity strategies is an effective way of limiting portfolio risk.
• Three in 10 (32%) global investors say their institution’s allocation to real estate is below target; 40% of investors in Asia and 39% in Europe report the same.
• More than one in four (28%) global investors say their institution’s allocation to socially responsible investing is below target; half (50%) of investors in the U.K. and 40% in the Middle East also report below target allocations.

Looking ahead to the next 12 months, institutional investors expect to face headwinds as they work to balance risk and return.

• Asked to select up to three priorities for the next 12 months, 27% say one of their institution’s top actions will be to pay more attention to correlations between asset classes.
• More than one-fourth (26%) named increase holdings of safe cash-like investments as a top investment priority in the next year.
• A similar proportion (25%) of institutional investors around the globe chose use absolute strategies.