In a bid to achieve long-term returns without incurring the risk of today’s choppy markets, Asia’s biggest institutional investors are increasingly opting for alternatives in their asset allocation. The majority of respondents in a survey of 120 Asian institutional investors no longer deem long-held industry norms – such as lengthy holding periods or conventional 60/40 splits – as the best way to manage their portfolios. Respondents, including sovereign wealth funds, pension funds and foundations, each with an average $15.4 billion of assets under management, said the financial crisis has forced a change in their approach to risk management and a reappraisal of portfolio construction.
“Asian institutional investors have been shaken by the failure of conventional investment theories to protect assets and produce returns,” said John Hailer, Asia and Americas chief executive officer of Natixis Global Asset Management, publishers of the report.
“We’ve found that they are applying the lessons they’ve learned to create more durable portfolios. Increasing the use of alternative investments and making smart use of traditional asset classes is more likely to help them reach their goals in the current volatile markets, which appear to be here to stay.”
Alternatives are here to stay
Terry Mellish, head of business development at Naxtixis in London adds:
“The traditional long-only way of constructing a portfolio is sometimes no longer relevant. Alternatives add alpha and they are here to stay.”
One of the reasons institutions are increasing their asset allocation to alternatives is because the financial crisis means that traditional assets now correlate. It means volatility and illiquidity bleed across bond and equity asset classes, leaving few traditional safe havens. “A significant majority (71 per cent) agree that the best way to temper market volatility is to increase allocations to non-correlated assets,” finds the report.
Alternative-asset allocation means investment in hedge funds, private equity and even venture capital are increasingly sought after. Risk budgeting is another key, with institutions increasing their allocation of liquid alternatives such as global macro or long-short equity strategies. The low-yield environment encompassing bond-like asset classes with regular income streams, such as infrastructure, and diversified fixed incomes spanning bank loans and emerging debt, are also popular. The report found “89 per cent of respondents cited increasing allocations to fixed incomes as an effective risk-management strategy”. Commodity and real-estate asset allocations were the least popular among investors looking at alternative allocations.
The shift towards alternatives is a direct attempt to try and manage risk, which is now viewed as the “new normal”, and the overwhelming worry for investors – or, as Mellish puts it, the “thing that keeps them awake at night.”
“In the past, most schemes looked at the risk once their portfolio was in place,” he adds. “Now they are putting that risk at the front of the process and factoring risk into all decisions.”
Mitigating volatility and so-called tail risk – those events that impact portfolios unexpectedly – is now at the forefront of managers’ minds.
Encouragingly, the shift towards alternatives among Asia’s biggest institutional investors is starting to pay off. The survey found that eight out of 10 respondents “were pleased” with the performance of their alternatives, with more than half expecting that their alternative strategies “will outperform last year’s returns.” The survey found “alternatives are important not only for diversification but also for performance. The majority of respondents believe it is essential to invest in alternatives in order to outperform the broader markets”.
Going forward, all the signs suggest alternative asset allocation and “new approaches to achieve results” will remain on the radar. Almost all respondents said government-debt levels and contagion from Europe will influence their investment decisions in the coming year and that the “staggered pace” of financial reform increases systemic risk. The findings – drawn from institutions in China, Japan, Taiwan and Singapore, and which chime with Naxtixis research across other regions – show institutional investors implementing and being rewarded for pursuing new and innovative strategies in today’s unchartered waters.
“Alternatives give clients the chance of achieving their long-term objectives but with fewer shocks along the way,” concludes Mellish.