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Survey finds historic change in asset allocation approach

09 October 2012

Category: News, Asia, Global

Fifty-two percent of institutional investors worldwide are rethinking traditional approaches to asset allocation over the next ten years, according to a Pyramis Global Advisors survey of pension schemes and other institutions from Europe, Asia and North America. These respondents oversee more than US$5 trillion in assets.

In recent years, amid market volatility and low interest rates, 41% of respondents said they became more “tactical,” or opportunistic, in their investment decisions. Despite that, 36% of these investors believe they will not achieve their return assumptions (ranging from 29% in the US to 40% in Canada and 51% in Europe).

Shortening the Time Horizon, the 2012 Pyramis Global Institutional Investor Survey, also reveals that global institutions require median annual rates of return between 3% and 8% to cover liabilities and, despite major changes in capital markets, this required return has not changed significantly in four years.

The survey, now in its tenth year, shows global institutions’ top concern is the low return environment (31%), up from 25% at the onset of the financial crisis in 2008. (Fifty-seven percent in Europe ex-U.K. cited the low return environment as their top concern.) To navigate this market, 41% of schemes expect to use a more dynamic or tactical (opportunistic) approach to allocating portfolio assets to boost returns. Achieving this, pension managers say they must:

• Conduct more frequent internal risk reviews (48%)
• Streamline decision making via pre-approved asset allocations (34%)
• Emphasise investment committee education (26%)

“In an effort to boost returns, institutions globally will have to accept more risk or different kinds of risk,” said Mike Jones, president and CEO of Pyramis. “We found that many institutions are increasing or diversifying their risk and changing the way they execute on investment decisions, while some are completely rethinking long-held beliefs about asset allocation.”

Among other key findings, institutions are seeking excess returns, assets with low correlations to public markets and assets with different risk and return profiles. As such, eight-in-ten pension managers believe picking the right market or region will be the primary source of future returns. Twenty-nine percent in the US, 30% in Canada, 33% in Europe and 23% in Asia said they would definitely or likely increase the use of more aggressive “sub asset classes” (e.g., emerging markets equity and debt). Alternative investments are also becoming more popular, as 38% of respondents expect to change their investment mix to add illiquid alternatives (e.g., private equity), while 22% expect to add liquid alternatives (e.g., hedge funds).

The survey also explored derivatives, which are required in implementing a more dynamic approach to asset allocation. The use of derivatives was relatively high at 64% globally. Forty-three percent report using derivatives to tactically adjust market (beta) exposure; 47% said they used them for “downside protection” or “tail risk.”

“For those who don’t have the internal expertise or resources to manage their portfolio more dynamically they’re turning to their investment partners,” said Derek Young, president of Fidelity’s Global Asset Allocation division and vice chairman of Pyramis. “That’s why it wasn’t surprising that our survey found that in the past two years, one fifth of surveyed US and European institutions had expanded their relationship with outside managers and employed a so-called outsourced CIO.”

In future, traditional models, LDI to be joined by new models such as absolute return

Even as some institutions look to broaden outside partnerships, the Pyramis survey found that some respondents are questioning long-held beliefs in the asset allocation models themselves.

More than half (52%) noted that with more highly correlated markets, their approach in the past will not be effective in ten years. When asked what they expect the traditional models to look like a decade from now, 26% said they will shift toward fixed income or immunised strategies (e.g., liability-driven investing or LDI), while 19% expect traditional asset mixes to prevail.

Among pensions managers (mainly US corporate, Japan and UK pension schemes), LDI figured prominently. More than half (51%) of the investors globally said they were using an LDI strategy.

Among those institutions expecting entirely new asset allocation models to prevail in ten years, nearly a third (32%) said they will shift significantly to both alternative asset classes or factor-based strategies (where allocation is based on specific risks). Meanwhile, 11% believe they will shift significantly to absolute return strategies. In total, 43% of institutions around the world are considering some new model.

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