Wholesale allocators plan to raise their exposure to alternative assets and stocks at the expense of fixed income this year, amid fears that geopolitical events are set to fuel higher volatility, according to new research.
Asian product selectors, meanwhile, are increasingly looking for unconstrained bond strategies, to reduce their “overexposure” to high yield, said Matt Shafer, head of international distribution at Natixis Global Asset Management. He was speaking to AsianInvestor ahead of the release today of the firm's first global poll of wholesale portfolio managers.*
Respondents said emerging-market shares – particularly those in Asia ex-Japan – were likely to provide the best equity performance this year. Around half (47%, the highest proportion) said EM stocks would be the bright spot among equity markets in 2017. By contrast, 40% predicted that US stocks would be a disappointment.
“The trend for professional fund buyers to rotate back into emerging-market equities started in Asia in November and has now spread to European and US banks,” Shafer said. “They had been looking for a catalyst to diversify away from US and global developed-market stocks.”
Asked to identify the most likely source of volatility this year, respondents' top choice (with 63%) was geopolitical events, followed by interest rates (49%).
According to the Natixis research, this year wholesale PMs plan to reduce their fixed income allocations by 3 percentage points on average and re-allocate the money to equities (+1.6 percentage points) and alternatives (+1.5). The forecast cut in bond exposure is “a clear reflection of the challenges presented by the low-yield environment”, said the survey.
Credit exposure concerns
One of the biggest risks for wholesale banks is overexposure to high yield, said Shafer, especially given its high correlation with stocks. “If you're adding equity exposure, that doesn't help you diversify from high yield.”
Wholesale fund buyers in Asia are realising this and looking to put more non-traditional fixed income products on their platforms, he noted.
“Whether it's in liquid alternatives or unconstrained bond funds, there is a clear proliferation now,” said Shafer. “We hear from a lot of fund selectors now – particularly in Singapore, but also in Hong Kong – looking for flexible bond strategies.”
They are realising the need for diversification to create a more durable portfolio with lower levels of correlation and more stable income and yield, he added. The biggest area of interest is in unconstrained fixed income, he noted, but there has also been a big pick up in demand for structured loans and structured credit.
But wholesale fund buyers face an uphill struggle in convincing clients to reduce their overexposure to high yield, said Shafer. “The reality that all pockets of the globe, including Asia, are faced with is that the desire for yield continues.”
Indeed, when asked which fixed income strategies would deliver the biggest gains in 2017, the highest proportion of wholesale buyers globally (47%) tipped a 'credit play with HY bonds'; in a distant second place were 'corporate bonds'.
Meanwhile, three-quarters (74%) of wholesale fund buyers said alternatives were essential for diversifying portfolio risk, and 54% that they were essential for outperforming the broad market. In addition, around half (52%) said their firm was embracing illiquid assets more than three years ago.
In terms of asset types, a quarter (the highest proportion) favoured private equity, closely followed (23%) by commodities. However, real estate and hedge funds were named as asset classes that would disappoint, with 32% and 27%, respectively, citing these assets.
“It's a big discussion [for fund selectors]: trying to decide which alternative strategies they want to put on their shelves,” Shafer said. They are looking to make up for their lack of expertise in private markets by recruiting more staff to cover private equity and private debt in particular, and by using external consultants, he added.
Meanwhile, fund buyers are seeking new types of exposure to commodities, said Shafer. “They are diversifying away from typical gold strategies and looking to get direct physical exposure to other commodities.”
Passive and active
Turning to the passive/active debate, while eight in 10 respondents said the current environment favours active managers, the flow into passive looks set to continue. Wholesale PMs forecast a 2.3 percentage point rise in their passive allocation to 27.7% of their total portfolio by 2019. However, Shafer argued that this increase suggested the momentum towards passive was slowing.
* The survey polled 200 professionals responsible for investment strategy and construction of model portfolios at private banks, wealth managers and insurance platforms.