However, fund buyers have reduced their long-term rate of return assumptions to an average of 7.7%, down from 8.4% in 2018. Against this backdrop of uncertainty, and in order to meet these return expectations, professional fund buyers are showing a clear preference for active management.

Against a backdrop of uncertainty, fund buyers choose active management

Fund buyers have rising concerns such as higher interest rates, greater equity market volatility and they experience performance pressure from forces including central bank unwinding of quantitative easing, geopolitical disruptions and trade disputes. Three-quarters of respondents agree that alpha is becoming increasingly difficult to obtain as markets become more efficient, and they are willing to pay higher fees for potential outperformance and agree that the 2019 market environment is likely to be favorable for active portfolio management. 

Louise Watson, Managing Director for Natixis Investment Managers in Australia, commented: “The majority of global fund buyers (62%) agree that actively managed investments outperform passive portfolios in the long run. While there is no one size fits all approach, even in their passive investments, over half of investors (55%) are allocating more to smart beta compared to three years ago.   Economic conditions are softer now, and markets more volatile, so fund buyers are valuing the long term value that can be generated by active management and the access it can grant to a broader range of asset classes. Even as the active passive debate continues, it’s clear that a one-size-fits-all approach isn’t going to be successful.”

Staying the course in risk assets overall; using alternatives as a route to returns and diversification

The survey revealed that fund buyers do not intend to make wholesale asset allocation changes in 2019, with a bias towards risk assets prevailing. Equities and fixed income remain the most popular asset classes by a large distance, however fund buyers intend to trim their overall equity allocation by 1.2 percentage points to 43% (down from 44% in 2018). They also plan to increase weightings in alternatives (+19% in infrastructure; +15% in private debt; +17% in real estate) with 70.1% of overall alternative allocations being made into liquid assets. Alternatives are seen as valuable tools to help meet performance objectives, manage risk and diversify holdings.

ESG is another year closer to the mainstream

Two-thirds (67%) of fund buyers surveyed said they agreed that including ESG factors will be standard practice for all investment managers within five years. Half (49%) believe that ESG factors are important in their organisation’s current manager selection process, and two-thirds say they will increase their allocation to ESG strategies in 2019. More than half (57%) contend that there is alpha to be found in ESG investing. Fund buyers are increasingly incorporating ESG considerations into investment decision-making and analysis to align investment strategies with their organisational values.  However, their concerns include the conflict between short-term return goals and long-term sustainability objectives, a lack of demonstrated performance track records and fears that companies may be “greenwashing” to enhance their public image.

Louise Watson commented: “Investment managers are in a powerful position to drive change by choosing where they invest. ESG investing is now mainstream – and growing stronger every year, with many local funds appointing dedicated ESG teams to respond to member demand. ESG themes offer attractive opportunities from an investment perspective but also in terms of social responsibility. Offering more retirement plans integrating ESG criteria could entice investors to save more, help to improve pension funding, and could lead to greater retirement security.”

Matthew Shafer, Head of global wholesale at Natixis Investment Managers commented: “Appetite for ESG is growing stronger every year as investors increasingly seek to reflect their personal values in their portfolio strategies, and the longer-term return benefits of sustainability are being more widely recognised. However, we do hear and share fund buyers’ concerns about “greenwashing”. Robust and clear taxonomy, labeling standards across the industry and across jurisdictions, and transparency around ESG reporting are critical to maintaining the integrity of ESG investment products. As a leading active manager, we have high conviction and we consider that engagement with management around ESG factors and exercising voting rights accordingly are part of active investing and long-term performance.”  

More meaningful changes within asset classes; U.S. equities down, emerging markets up

Just under half (44%) of fund buyers say they plan to decrease their allocation to U.S equities, with opinions evenly balanced towards European equities. A significant portion (39%) of fund buyers indicated that they plan to increase their allocation to emerging market equities in 2019. Fund buyers expect the financials, healthcare and information technology sectors to outperform, and expect materials and real estate to underperform. Attitudes towards fixed income allocation remain largely unchanged year-on-year. The most notable exception is a reduced enthusiasm for high yield debt, due to concerns over rising interest rates and the ability of high yield issuers to meet their debt obligations. 

The survey also revealed notable portfolio risk factors include rising interest rates, volatility and market bubbles:

• More than half (58%) of the fund buyers surveyed identified rising interest rates as a top portfolio risk in 2019, with 78% of fund buyers expecting interest rates to go up during the year. 
• Volatility is also a prominent concern among fund buyers: 84% of those surveyed expect increased volatility in equity markets in 2019. 
• Almost two-thirds (60%) of fund buyers believe that regulation, put in place after the financial crisis, has done little to mitigate current and future market risks.
• Fund buyers also remain wary of market bubbles. They see most danger in cryptocurrencies, in addition to technology, bond and real estate markets.

The full report of the 2019 fund buyers survey Ready. Steady. And waiting. is available here

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The survey revealed geopolitical events (67%), interest rates (49%) and China market woes (36%) as the top three sources of volatility for 2017. The low-yield environment tops the list of risk management concerns (77%).

Professional buyers believe that higher levels of market volatility are likely to result in greater dispersion in equity returns. 95% of those surveyed said they would choose active management over passive investments for generating alpha, while active management is also the preferred route to gain exposure to non-correlated asset classes (74%) and emerging markets (77%).

Matthew Shafer, EVP of International Distribution, commented: “While keeping a close eye on political and macroeconomic shifts in Europe and Asia, professional fund buyers see volatility as an opportunity. That is why they are looking to active management to both generate alpha and manage risk.”

Although professional buyers anticipate greater volatility in the year ahead and are concerned about investors taking on too much risk, they are not shying away from adopting risk, which is reflected in their market outlook and asset allocation calls.

Professional fund buyers are resetting strategy to ensure they are positioned for volatile, uncertain markets. Three-quarters (74%) pointed to alternative investments as a means to diversifying portfolio risk. More than half (54%) also say it is essential to invest in alternatives in order to outperform the broad market. This correlates with Mackay Williams’ latest Fund Buyer Focus which showed a greater emphasis from professional fund buyers on alternative and thematic strategies.

“We are seeing a marked shift from the old passive and long only active model to a new mix based on a core of active and low volatility alternatives with the addition of liquid and illiquid alternatives,” said Shafer.

When it comes to asset allocation, the consensus view among professional buyers is that emerging market stocks will shine in 2017, with 47% projecting this as the bright spot among equity sectors. In pursuing emerging market opportunities, fund buyers are looking to Asia Ex-Japan to provide the best performance in 2017.

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