Regulators’ failure to consider “the bigger picture” has driven institutional investors into risk imbalances, according to Michael Schmidt (pictured), managing director at Union Investment. 

He said a growing number of German institutional investors had reduced their equity exposure in recent years and were instead increasing exposure to real assets such as infrastructure and real estate. 

“The fact is, last year was the first year since the crisis in which investors could not afford not to be in equities, and we expect 2014 to be similar,” Schmidt told IPE. “But still not many are making new investments in equities.”

Among German insurers, the average equity allocation is currently in the lower single digits, despite the fact German insurance law allows for greater exposure.

Yet Schmidt said he was still convinced regulation was at least partly to blame for institutionals’ withdrawal from the asset class. 

“Static risk-parity models are telling investors not to hold too much equities because of the historical data that includes the financial crisis – but this is not the scenario we are expecting for 2014, and mark-to-market valuations prevent long-term equity investments,” he said.

And while Schmidt recommends adding infrastructure and other real assets to portfolios as a diversification, he said he was concerned some investors might lose sight of the right risk balance. 

“Equities’ main risk is short-term market volatility, and while single infrastructure investments are more stable from a valuation perspective, there is counterparty risk and liquidity risk,” he said. 

“In the end, investors need to make a deliberate choice of the risks they want to take on. A prudent approach would suggest diversifying across all kinds of risks.”

Pointing out that equity markets are often criticised for the “fragmented” liquidity caused by short-term traders, Schmidt argued that the increase in short-term trading filled a void left behind by “the strong long-term investors who have left the markets”. 

“Half of the German DAX is now in foreign hands because German investors, institutions and private savers alike have divested drastically from it,” he said. 

According to figures released by the European Investment Bank, the de-risking trend among institutional investors worldwide has brought down equity exposures from 60% in 2001 and 2006 to 47% in 2012. 

Schmidt argued that regulations were focusing too much on one particular theme, such as high-frequency trading, instead of looking at the big picture. 

“Regulators do not support long-term equity investors or encourage them, despite their important role for the capital market,” he said.