Many firms are now engaging in surveys to provide insight on the direction of asset allocation choices of large investors. Natixis Global Asset Management just released their 2016 survey of institutional investors which provides interesting reading. It tells us that institutions want efficient diversification, different asset class and strategy choices that efficiently use capital. The top objective for institutions is not about growing or preserving capital but achieving the highest risk adjusted returns. This plays nicely into the higher demand for alternative investments. The one thing that hedge funds do well is more efficiently use capital and this seems to be the desire of investors.
Of course the big elephant in the room for any investor is the threat of higher interest rates from a Fed normalization. 2/3rds of institutional investors plan to shorten bond durations as a way to respond to this threat. Unfortunately, lower durations comes at the cost of lower yields. Protection against rate increases will cost yield in the short-run and lead to lower realized portfolio returns. This is another reason for the increased demand for alternatives.
The largest decrease in allocations will be to the fixed income asset class. The largest increases will be toward equities and private equity. It is interesting that while rates are expected to increase, there is a desire to hold more equity during a period of Fed normalization. The expectations is that real rates will rise from improved growth and there will be higher inflation based on a strong economy. Equities are being viewed as an inflation hedge with expectations for higher earnings. There is the implicit belief that a bad bond environment is a good stock environment based on continued negative correlation between the two main asset classes. That is an assumption that may not be realized.
Still, there is a strong desire for holding alternatives as a means to break-out of the two asset diversification between stocks and bonds. From the survey, the main driver for holding alternatives is diversification and not alpha generation. The value of risk mitigation falls right behind the demand for alpha generation.
The core problem with 2016 for institutional investors is clear. There is an expectations that rates will rise, but the alternative of holding more equities may not be palatable. This means that alternative investments will have to serve as the go-to place for diversification and risk control.