German institutional investors are being encouraged to ramp up efforts to diversify their investment portfolios beyond their domestic and European markets, according to Union Investment.
Equities in developed countries, including Japan and Great Britain, and US high-yield bonds could improve the performance of investment portfolios, research by the firm showed.
Emerging market government bonds and US investment grade corporate bonds could add to higher expected returns and an improved risk return ratio for overall portfolios, albeit with increased volatility, it added.
According to the analysis, emerging market bonds (hard currency bonds in US dollars) are the most attractive from a return risk perspective. A partial hedging should take place for the currency risk of these investments.
Institutional investors could also revamp their portfolios by adding further asset classes such as commodities or real estate, as well as by pursuing new strategic approaches such as thematic investing.
Union Investment has identified three thematic megatrends that could lead investors to allocating capital:
- social and demographic developments;
- digitization, connectivity and innovation; and
- globalization, climate change and scarcity of resources.
Equity investments are key to avoiding low returns in the current capital market environment, it added. ’Home bias’ and ’near bias’, as Union Investment calls allocations limited to Germany and Europe, still drive institutional investors’ main allocations.
Data on Spezialfonds in particular shows that equity and bond investments are concentrated in Germany and in the Euro area. Spezialfonds invest 15.7% in equities of German companies, compared to 2.4% in the MSCI AC World Index, while almost 17% of equities in the funds stem from the rest of the Euro region, clearly more than 3.5% for the benchmark.
Germany is also “overrepresented” for bonds, albeit less strongly than for equities, with 13.7%, compared to 5% in the BofA Global Broad Market Index.
Exposure to German equities, however, fell from 30% in 2007 to 19% in 2020, rebalanced with an increase in equity allocation in North America from 8% in 2007 to 23% in 2020, driven by the growth of big tech firms in the US.
The geopolitical situation remains “fragile”, Union Investment’s research noted, especially for the standoff between the US and China on top of the COVID-19 pandemic.
The firm’s long-term capital market outlook in this analysis highlighted that the “tectonics of the global economy” will not shift dramatically and that capital markets will “adequately reflect” political and real economic events.
It added that regulatory changes may slow down the construction of a global portfolio, citing Solvency I and II guidelines for insurance companies, Pensiosnskassen and Pensionsfonds.