Asian institutional investors believe the best investment opportunities for 2018 lie in the region's emerging markets, and believe allocations to alternatives are vital to outperform, according to a global survey of institutional investors by Natixis Investment Managers released on February 28.
Forty-nine percent of regional asset owner respondents, including corporate and public pension funds, foundations, endowments, insurance funds, and sovereign wealth funds, are looking to put money to work in Asia’s emerging markets, the survey said.
“There’s definitely a trend among Asian investors wanting to invest more in Asian markets,” Fabrice Chemouny, head of Asia Pacific at Natixis, told AsianInvestor.
Over the past decade, Asian institutional investors had been more focused on global fixed income and global equities, but now there is increasing appetite to invest closer to home, with emerging markets seen to offer the best opportunities, he added.
Emerging Asia, which includes countries such as China, Indonesia, and Malaysia, is a top investment opportunities for institutional investors, Adeline Tan, wealth business leader at consulting firm Mercer, agreed.
“The Asia growth story is certainly stronger on a valuation basis [versus US and Europe]; it's also home turf, so there is some knowledge bias there as they know these markets,” she told AsianInvestor.
While still mainly invested in their home markets, Asian institutions are slowly but surely diversifying away and into other markets in the region, said Chemouny.
Apart from diversification, the region offers appealing returns, which helps explain the attraction for investors. Last year, MSCI’s Emerging Markets Asia Index soared 42.8%, outperforming MSCI’s US and Europe indices, which pocketed returns of 21.9% and 26.2%, respectively.
The Asia EM index continued to outpace the US and Europe indices in January 2018, posting returns of 8%, versus 5.7% for the US index and 5.4% for the European counterpart.
In terms of valuations, the Asian Emerging Market index's price-to-earnings ratio was at 16.2 as of 31 January 2018, compared to 25.7 and 20.6 for the US and Europe indices, respectively.
Natixis IM’s Chemouny noted that the shift fowards greater Asia and Asian emerging markets was occurng across all asset classes.
“The goal is to have a better balance in their allocations across Europe, the US and Asia. Asia emerging markets should represent roughly a third of their allocations going forward,” he said.
One good example of a regional investor looking at investing in the region is Taiwan’s Bureau of Labor Funds, which is hoping to increase its exposure to Japan equities on the back of macroeconomic improvements in the country and labour policies conducive to economic growth.
Mercer’s Tan noted that quite a few of the consultancy’s clients already have between 20% and 30% of their allocations in Asian emerging markets, especially within equities.
“Investors that are less risk-taking would possibly have 20% of their investments across emerging markets, but Asia’s share is likely be very large in that allocation,” she added.
In terms of overall portfolio returns for 2018, investors are hoping to generate anywhere between 3% and 8%, Chemouny said, depending on the risk appetite.
The Natixis IM survey showed that 52% of institutional investors in the region believed investment in alternatives was essential to outperforming the broader market, while 75% of respondents said that alternative investing was necessary to diversify portfolio risk.
The survey, which was based upon 500 investor responses, defined alternatives to include real estate, private equity and private debt.
Korean institutional investors in particular have shown a strong focus on alternatives, according to Chemouny. “They are probably the more aggressive in terms of demand for alternatives,” he noted.
Korea’s Public Officials Benefit Association (Poba), for example, has a 49% allocation to alternatives as of December 2017, and it is looking to further diversify and grow its alternative investments, including real estate and infrastructure.
The survey also mentioned that 37% of Asian institutional investors cited hedged equity as best suited to manage volatility risk, while 35% believed managed futures to be the better volatility risk management option.
Low yields from traditional assets has encouraged regional institutions to look at infrastructure in particular, with 43% Asian institutions naming it the top choice to replacing fixed income as a source of stable returns, the Natixis survey noted.
“From our conversations with clients, we can see there is strong demand for infrastructure,” said Chemouny. “This is a space that banks have gone out of because of regulations. They no longer finance this kind of infrastructure, and this is definitely something investors are seeking,” he added.
The Basel III rules, which requires banks to maintain specific leverage ratios and minimum capital requirements, make infrastructure lending less appealing and more expensive for banks. This has opened the door for institutional investors to fill the funding gap.
Many institutions are weighing their options in investments ranging from listed infrastructure funds to real estate investment funds. But there has yet to be a major shift from fixed income to infrastructure, noted Tan.
“[Infrastructure investments] are almost seen as a fixed income replacement for yield, but for now, they are not willing to take the risks,” said Mercer’s Tan.
Instead, those who invest in infrastructure-related assets invest with the aim of achieving diversification within a private markets portfolio. “Investors are not looking to outperform private equity returns; it’s more about hedging risk,” Tan said.
According to the Natixis survey, 43% of the region’s investors surveyed believed infrastructure offered the best strategy for diversifying portfolios.
Infrastructure is undoubtedly popping up on the investment radars of some of the region’ biggest investors: in January 2018, Japan’s Government Pension Investment Fund (GPIF), the world’s largest pension fund, awarded its first ever infrastructure mandate to US-based investment manager Stepstone Infrastructure and Real Estate, though the focus of those investments are likely to be the brownfield, or assets that have already been built and are in need of further investment, projects in developed markets.
Hong Kong-based insurer FWD Group is also looking for infrastructure investment opportunities, particularly in the Asian greenfield space, where projects are planned and executed from the ground up.
However, the lack of high quality projects in Asia limits the pace at which regional institutional investors can deploy capital in infrastructure, Mercer’s Tan said.