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Institutional investors manage risk with alternatives and smart beta

Institutional investors are changing their attitudes to managing risk in their portfolios, according to a survey from Natixis Global Asset Management. Risk budgeting has become commonplace, and allocations to alternatives and smart beta are being beefed up.


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Some 87% of the 500 institutional investors surveyed by Natixis now use some form of risk budgeting to manage portfolio risk. Alternative investments are also increasingly considered an important risk management tool: three quarters of respondents plan to increase their allocation to alternatives this year, up from just over half a year ago.

“This may be partly the result of frustration with the limitations of traditional assets and partly the result of greater dispersion of returns brought on by more volatile markets,” said Chris Jackson, deputy CEO at Natixis.

The results of Expert Investor’s regular asset allocation surveys also show continuous appetite for so-called absolute return strategies. Many investors continue to replace part of their fixed income holdings with absolute return funds, even though the latter have delivered disappointing performance in recent years.

Overall, institutions anticipate that they will increase allocations to alternative investments by 4% in 2017, increase equity allocations by 1.7%, and reduce fixed-income holdings by 3.5% according to the survey.

“While these adjustments may appear to be small, under the surface they may indicate a bigger transition in portfolio strategy,” said Jackson.

As fixed income is unpopular overall, institutional investors are eager to invest more in private debt (read Expert Investor’s March issue for a comprehensive overview of this asset class). 73% of survey respondents believe private debt provides higher risk-adjusted returns than traditional fixed income. The same percentage say they would invest more in private debt if there was a broader range of options available.

Active management is back

Finally, active management is returning to favour, as higher expected market volatility is supposed to create more dispersion in returns. Last year, institutional investors appeared ready to commit significant assets to passive investments. At the time they assumed a 7% increase in allocations to passive within three years.

“Projections from 2016 survey respondents demonstrate a significant moderation of sentiment, with institutions anticipating an increase of just over 1% by 2019,” said Jackson.

 ource atixis Source: Natixis

So-called smart beta investments, however, are rising in popularity. Two thirds of survey respondents say they plan to increase their allocation to smart beta products in an effort to better manage portfolio risk. This suggests these respondents consider smart beta an active rather than a passive investment.