Over the last three years, extending a trend that began in the wake of the financial crisis, the average institutional investor has transitioned its investment portfolio to one that is not only more complex and diverse, but which features a greater proportion of illiquid investments, according to the findings of the 2018 Global Asset Owner Survey, a just-released report from bfinance, a London-based specialist investment consulting firm.
Some 66% of survey respondents said they have added a new asset class to their portfolio, led by private debt, infrastructure, real estate, emerging market equity and alternative risk premia. Another key finding of the report: 49% of institutional investors surveyed have increased their allocations to private markets, though nearly half of investors are currently underweight versus their allocation target for this asset class.
“In essence, this paper explores a fundamental tension: There is a gap between the returns that many investors need and the expectations now for what a traditional portfolio is likely to deliver over the next twenty or thirty years. In this study, we can see investors responding, making significant changes, adding complexity, adding illiquid, but at the same time improving overall efficiency as well,” according to Kathryn Saklatvala, investment content and thought leadership director at bfinance, in an introduction to a Sept. 17 webinar that discussed the report’s findings.
The far-reaching survey of nearly 500 investors, with assets approaching US$8 trillion in aggregate, found that although the average institutional investor has transitioned to a more complex portfolio, featuring greater use of non-traditional (and typically costly) asset classes since the financial crisis, they have achieved savings which more than outweigh those additional expenses. As a result, a summary of the report’s findings says, average costs have fallen rather than risen.
“Teams are grappling with increasingly prominent ESG [environmental, social and governance] issues and substantial changes to risk management. ESG is less of a high priority for U.S. investors than their global counterparts. Yet many are introducing new ESG policies and the issue is set to play a major role in future manager selection,” according to a press release accompanying the report’s release. It continues: “Meanwhile, despite greater use of alternative investments, investors appear to have reduced costs and the total fees paid to external managers. Renegotiation, mandate consolidation and transaction cost analysis have proved to be key tools in the investor’s arsenal, while 31% of investors have shifted toward passive management in the past three years.”
Among the survey’s key findings are:
- Increased allocations to illiquid investments—Over the past three years, 66% of investors have added at least one new asset class or investment strategy to their portfolios, with an additional 9% of respondents planning to do so imminently. Overall, private debt strategies were the most popular new addition, particularly in Europe, followed by unlisted infrastructure, unlisted real estate, emerging market equity and alternative risk premia.
- Cost reductions are evident across all asset classes—Only 27% of investors say their overall costs have increased as a percentage of assets, while 41% say they have decreased. Meanwhile, 51% of investors are paying less in total external asset management fees versus 17% who have seen fee spend increase. Unexpectedly, investors that have increased allocations to private markets are among the most successful in reducing costs, along with European and Australian asset owners.
- Hedge fund portfolios are being overhauled—Hedge fund investors are seeking better diversification and 55% have either overhauled their portfolios to reduce directional equity exposure within the last three years or plan to do so this year. Of those invested in hedge funds (56%), 34% have reduced their allocation to this sector over the past three years and 23% have increased allocations.
- Shift to passive management—A significant minority of investors have moved in the direction of passive management or smart beta during the past three years, at 31% and 20% of investors, respectively. However, the majority of investors believe that active will outperform passive over the next 12 months. Greater emphasis on ESG could also favor active management, with nearly half of investors believing that good ESG integration requires an active, as opposed to a passive or systematic, approach.
- ESG considerations increase in importance—ESG considerations are growing in prominence, with 39% stating that it is a “high priority” for their institution and 43% implementing a new ESG policy either in the last three years or this coming year. Larger investors are more likely to prioritise ESG issues, while North American asset owners are considerably less likely to do so. There are significant implications for implementation, including manager selection, where 41% of investors say ESG considerations will play a “major” role going forwards.
- Trusted partners—33% of investors have increasingly used asset managers for strategic advice, while 23% have increasingly used consultants for asset management services. The lines between advice and asset management are increasingly blurred, with players on both sides seeking to take ownership of the coveted middle ground: influence over strategic decision-making is, as providers increasingly understand, a key driver of asset management revenues. Yet 45% believe that asset management by consultants represents a “conflict of interest.”
- Rise of specialist consultants—Multiple-consultant usage is now relatively commonplace, with 57% of survey respondents globally using two or more consultants in the past year and 31% using three or more. This development should be viewed in the context of a climate where investors are hunting for innovation, in-house investment teams are increasingly sophisticated and selective, consulting models are coming under greater economic pressure and conflicts of interest are provoking concerns.