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Investors 'warming' to alternative ways of viewing portfolios – survey

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Institutional investors may be warming to approaches beyond traditional asset class-based allocation regimes, with many also turning to factor or objective-based alternative investment models, according to a survey commissioned by State Street Global Advisors.

Conducted in the second half of last year, the survey was of senior executives with asset allocation responsibilities at 400 large institutional investors from around the world.

It focused on investors’ objectives, their approach to asset allocation and their framework for measuring success.

According to State Street, the survey shows investors are “reassessing strategic asset allocation models and turning to objective and factor-based approaches to better achieve investment objectives in a low-return environment”.

Respondents’ long-term return expectations were generally elevated across most asset classes, raising the question of whether these were overly ambitious, State Street said.

For example, they are looking for a return of 10.9% on the long-term performance of their portfolio, 10.9% in real estate, 8.1% in commodities, 10% in equities and 5.5% in bonds.

More than half – and in some cases more than 75% – of respondents said their return expectations were being met (plus or minus 1%) for the overall portfolio and in different asset classes.

However, nearly one-quarter of respondents (20%) said their long-term return expectations were not being met, with only 13% saying that, on average, their expectations were being exceeded (State Street pointed out that the survey was conducted before the significant market downturn at the start of this year).

For Rick Lacaille, CIO at State Street Global Advisors, the survey shows institutional investors are “beginning to question whether they can achieve objectives through traditional investment models in the current lower-for-longer return environment”.

He added: “Not only does this challenge traditional, strategic asset allocation models by forcing greater consideration of risk, but it also confronts investors with a need to focus from a top-down perspective on the drivers of returns in their underlying asset class choices.”

Investors, State Street noted, have traditionally viewed their total portfolios through the lens of asset classes, and 41% of respondents said this was the most important asset classification method – simplicity was one of the reasons cited.

However, the survey revealed the “significant adoption by many investors of an additional layer of factor-based classification (or by assets’ exposure to different types of risk)”, according to the asset manager.

Although 30% indicated their primary method was to classify assets by factors or exposures to types of risk, 65% said they applied this method in addition to others.

A further 55% also classified according to assets’ contribution to their portfolios’ overall objectives, such as growth or income.

“This may be evidence of a warming to approaches beyond rigid asset allocation regimes,” said State Street.

A breakdown by investor type is not provided in the report, although pension funds are described as being most traditional in their approach, with nearly half of respondents saying they focused on asset class-based categorisation.

This compares with two-thirds of sovereign wealth funds (SWFs) indicating that factor exposures and contribution to objectives served as the primary method for classifying assets.

For those respondents whose overall portfolio was performing below expectations, the most popular change in approach identified was to increase the allocation to alternative investments – SWFs (42%) and pension funds (24%) were more likely to feature this approach as their most preferred, according to State Street.

“Other popular tactical changes included the introduction, or increased use, of objective-based investing (selected by 63% of respondents), and an increased use of active managers (selected by 59% of respondents),” said the asset manager.

However, the survey also showed investors feel they face significant barriers to adopting new approaches, according to State Street.

These include limited or slow peer-group adoption of strategies such as smart beta (60% of respondents), difficulties obtaining board buy-in (46%) and a lack of in-house expertise (46%).

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