The biggest challenges facing institutional investors in 2021

Francesco Martorana, CEO, Generali Insurance Asset Management explores some of the key investment risks for insurers including low yields, cyber security, and a greater focus on ESG

Sara Benwellposted on Monday, January 04, 2021

Image by Gerd Altman https://pixabay.com/illustrations/road-new-year-2021-city-buildings-5799603/

The year 2020 has been marked by the global coronavirus pandemic, the fastest market sell-off – and recovery – on record, and the turbulent US presidential election.

Notwithstanding the strong recovery in 2021, economic, political and social disorder should continue in the future. While euro area GDP is expected to return to pre-Covid level by end-2021, we still expect the crisis to leave long-standing scars, with potential growth set to fall and inequality keeping the social fabric more fragile. 

Institutional investors will need to further adapt to the low return environment, anchored by secular stagnation and new monetary policy frameworks. Average inflation targeting (AIT) will likely become more popular.

"Institutional investors will need to further adapt to the low return environment,"

The extremely low level of real yields is filtering through valuation across all asset classes. In this new paradigm, rates volatility is durably low, positioning is crowded, valuations get stretched, corrections become more frequent and the diversification benefits diminish (fixed income returns will not offer as much cushion through recession or risk-off correction).

Therefore asset owners and asset managers need to put risk scenarios and tail risk hedging at the core of their investment strategies. Low returns will also threaten fee generation, hence AM revenues.  

The low return environment will make it harder for savers to reach their retirement financial targets. This is both an opportunity and a challenge for asset managers: saving ratios will be higher, which will boost for asset under management; but asset managers will also need to offer the right products, with the right balance between safety and returns.

"Asset owners and asset managers need to put risk scenarios and tail risk hedging at the core of their investment strategies"

In the meantime, Institutions for occupational retirement provision (IORPs) have been heavily impacted by the COVID-19 crisis, which has seen a significant drops in the funding ratios.

The search for yields implies that private assets will play a more important role in the portfolios going forward, as confirmed by most institutional investors surveys. This is both an opportunity and a challenge for the asset management industry, given that a lot of money is going to chase a relatively limited pool of assets, especially in the Eurozone.

Globally, there are $ 2.6 trillion in dry powder (i.e. capital committed and not yet invested) from private equity and private debt funds.

Furthermore, to avoid regulatory and reputational risk, asset managers and consultants must enhance communication to their institutional clients, especially on liquidity risk. Gating and suspensions occurred on real estate funds and some “unconstrained” multi-strategy funds represent a lesson learned.  

"The search for yields implies that private assets will play a more important role in the portfolios going forward"

Asset managers need to accelerate the integration of ESG into the investment process. Above and beyond any ethical conviction, ESG is a key dimension of financial risk and return that cannot be longer ignored when taking portfolio decisions. 2020 showed strong ESG resilience, both in terms of fund flows and risk-adjusted returns.

New trends are emerging. First, ESG is fast spreading from equities to a broader universe, including fixed income. Second, the ‘social’ factor is gaining momentum following the Covid-19 crisis. Negative screening and best-in-class approaches are necessary but not sufficient: active managers can make the difference on thematic and impact investments, including active engagement towards issuers.  

The rise of passive investment, and the decline in margins, is an obvious challenge for the industry. More than a fifth of AuM are now managed passively. Surveys suggests this may rise to 30% over the coming years. But active management remains key: capital markets cannot work without price discovery, therefore active management is even more important in conjunction with growing passive strategies.

"The rise of passive investment, and the decline in margins, is an obvious challenge for the industry."

The crisis marked a revolution in how institutional investors interact with asset managers. Market participants were able to adapt quickly to remote working also for portfolio management and trading. Looking forwards, some of the digital tools and apps already popular in the wealth management industry – where digitalisation and direct client servicing by financial planners are common – will find a place in servicing institutional clients.

The fast transition to digitalization in the investor-asset manager relation also creates new cyber security risks, not only in video-conference tools, but also on the operational side.

Surveys suggest institutional investors are seeking for a more selective and intense relationship with a small pool of lead AM providers. This pattern was only reinforced by the crisis, that reinforced relationships with incumbent providers rather than new market entrants.

Great attention and professionalism are needed. As the main asset management of the Generali group, we are used to a long-term view and have developed strong skills in credit analysis. Bonds remain important asset classes but today we need to aim for sustainable growth, also looking at the decorrelation from market risks and try to contribute to the recovery, as in the case of real assets and infrastructures.

 

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