Alvise Hero Banner
Global Head of Client Coverage
Alvise's Content Para 1
Many challenges face institutional investors over the next five years, but perhaps the biggest is the fact that the challenges are interconnected. These interconnections generate both complexity and a need for additional urgency.
If it was a standalone issue, I think institutional investors would find it much easier to adapt. However, climate change links to a rapidly shifting social context that in turn drives changes to investor demands and a very dynamic regulatory environment.
These trends are both amplified and accelerated by technological innovation, adding significant cost and time pressure. Viewed like this, investing is a complex ecosystem. Like its counterparts in the natural world, it is an ecosystem that can recover quickly from single events, but can come under great stress when hit by many events at once.
All of this is playing out against the backdrop of a dearth of returns in traditional core asset classes, particularly for higher-rated government bonds. Bloomberg data in November 2020 showed negative-yielding debt at record levels of around $17 trillion. The consensus view is that this will increase before it falls. This low-return environment makes meeting the many other challenges yet more difficult.
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To maintain consistent returns in an environment where the yields on safer asset classes have been squashed, investors are considering less-liquid categories of debt, more elaborate equity strategies and more private assets. For many investors managing pension assets in developed countries, they may have no choice: either invest in intrinsically riskier assets or fail to pay the pensions they have promised.
With portfolios more tilted to private assets, institutional investors will need to upgrade their expertise and tools. Those that invest directly will need to make substantial investments in specific in-house technology and risk-management tools and processes. Those using outside managers will still need to accelerate their data-driven manager oversight, as private assets take an increasingly important role in overall returns.
Equally, in public markets, and with an eye on costs and scale, institutional investors will continue to shift investment - equities and fixed income – into index-based strategies. However, to try and enhance returns and improve risk management, they will replace investments based on capitalization-weighted indexes with investments using factors, ESG and thematic portfolio construction technology. This will require better access to data, more sophisticated tools and newer investment technology that many still do not possess.
There are no silver bullets. This will require a profound transformation of how institutional investors operate in every aspect.
Looking across these changes, it is clear that institutional investing is increasingly an activity in which scale is vital. Larger investors can more easily invest in the data capabilities needed to oversee these more complex investment strategies. They should also be able to drive down costs, always particularly welcome in a lowreturn environment.
We have seen some moves toward investor consolidation. In the U.K., the central government pushed its 91 local authority pension funds into larger investment pools. In Australia, large mergers have taken place after a public inquiry by the Australian Prudential Regulation Authority into the nation’s then AUS$2.9 trillion compulsory pension scheme found outsized fees being charged to workers.
It’s difficult to predict how things will play out in other jurisdictions. Formal mergers are complex, but there is still scope for collaboration that can help cut costs and make it easier to deploy (and understand) cutting-edge tools in areas like climate change and risk management.
The investment ecosystem was evolving quickly even before the pandemic, and COVID-19 has given these changes still greater velocity. Rapid change is inevitable: the way ahead is to recognize this and embrace it.