High Hopes for Equities in 2016 Despite Volatility

“The research also found that investors believe global political turmoil and changing interest rates will make markets more volatile,” Natixis explains. “In response, they plan to increase diversification and devote more of their portfolios to alternative assets.”

Compiling the projections of some 660 large institutional investors, Natixis finds high hopes for equities across the board—although certain asset classes are expected to perform better, potentially much better, than others. For example, the survey finds a pretty strong consensus that global stocks will outperform both U.S. and emerging markets equities.

David Lafferty, the chief market strategist for Natixis, tells PLANSPONSOR institutional investors continue to seek out non-correlated assets, “and their attraction to equities has as much to do with their aversion for bonds in the current environment as it does with their enthusiasm for stocks.” Over the next year, most institutional investors will maintain or raise their holdings of non-correlated assets, Lafferty adds, including 50% who will increase private equity holdings and 46% who will increase private debt.

Another 41% will increase allocations to hedge funds and 34% will add hard assets such as real estate, according to Natixis. The slight majority believes their alternative assets will perform better in 2016 than they have this year.

NEXT: Bond use expected to decrease 

According to the Natixis study, institutions currently allocate 28% of their portfolios to fixed income.

“Over the next year, 42% of institutions expect to decrease their allocation to fixed income, the largest allocation decrease of all asset classes,” the report explains. “The same percentage of institutional investors plan to maintain their allocation and only 16% plan to increase their allocation to fixed income.”

More than half of institutions predict global politics will be one of the primary causes of market volatility next year, Natixis finds. A near-majority of investors cite macroeconomic woes in China (49%), differing international monetary policies (47%) and changes in interest rates (46%) as top market headwinds in 2016.

John Hailer, Natixis Global Asset Management CEO for the Americas and Asia, says the firm’s clients are eager to improve their income and performance in this environment. “We’re seeing a surge in demand for innovative strategies that target specific needs across more diversified, complex portfolios,” he notes.

NEXT: Portfolio shift

One result of increasingly complex portfolio demands is the use of hybrid approaches to active and passive investing, Natixis finds.

“The survey found institutions are using actively managed investments to generate alpha and for exposure to non-correlated assets,” the study says. “They use passively managed investments primarily to minimize management fees. Notably, two-thirds of investors (67%) believe world economic factors and higher market volatility will favor actively managed assets over passive investments in 2016.”

Responding to interest rate pressures and pending rate hikes from the U.S. Federal Reserve, the majority of institutional investors (65%) will move from longer-duration bonds to those with shorter durations. Other adjustments include reducing overall exposure to bonds (49%), Natixis finds, as well as raising allocations to alternative investments (47%) and using absolute return strategies (32%).

Lafferty feels there are a few points of conflicted thinking contained within the data—for example, most institutional investors say they are focused on risk-adjusted returns more than absolute returns, “but they’re still tilting their portfolios towards equities, which historically are not the best asset category for risk-adjusted returns.”

“The move towards alternatives makes more sense given the focus on reducing risk,” Lafferty concludes, suggesting it's critically important for investors to look beyond the anticipated (short term) Federal Reserve policy-driven bond market volatility in favor of longer-term trends, which suggest bond investment demand will only increase as the investing population ages dramatically in the coming decades.