By Christopher Faille
A new consultant survey forecasts that investors in the months to come will be looking for opportunities in hedge funds, funds of funds, and non-U.S. stocks, including equity in the emerging markets. The survey indicated, further, that there will be at least a short-term decline in demand for domestic equity and long-duration bonds.
The survey, a joint product of Casey Quirk and eVestment Alliance, is their sixth annual survey of U.S. investment consultants. This year’s survey, conducted in December 2011 and January 2012, took in 30 respondents, who together represent $9.7 trillion in U.S. investors’ assets under advisement.
The consultants expect that four distinct themes will drive search activity in 2012: the need to generate steady income in a low interest rate environment; the movement of alternatives into core positions within portfolios; continued portfolio globalization; and a shift by corporate pension plans toward liability-driven investing. LDI, as distinct from benchmark driven strategies, looks to match predicted expenditures against expected revenues, after accounting for predictable windfalls, irregularities, and inflation.
The first of those trends is driving the second. Consultants believe that “the plurality of search activity in 2012” will focus on “hedge funds, private equity, and real estate” as part of a shift to outcome-oriented portfolios.
Under the heading of the third theme, globalization, one may of course say the same: that the pressure to meet investor objectives is leading one-time U.S. focused investors and managers to look abroad. There is the even more secular trend, observed by the philosopher William James more than a century ago, that the world is growing more unified “by those systems of connexion at least which human energy keeps framing as time goes on.”
As a matter of consultant jargon, there is a distinction between “international equity” (portfolios that consist of equity from the world, with more emphasis on the developed than the emerging world, and excluding the U.S.) and “global equity” (portfolios that consist of equity from the world, both developed and emerging, and including even the U.S.) In 2011, the surveyed consultants thought that appetite for international equity would outpace demand for global equity. But this year their sentiment is the other way: they expect more focus on the global portfolios.
None of this means that domestic U.S. equity will become a backwater. There will still be a lot of search activity devoted thereto. Indeed, as the above graph indicates, if the consultants are right 19 percent of 2012’s search activity will be directed to this area. But only a modest 5 percent of 2012’s search activity will represent new mandates for that asset class, the rest will involve the replacement of existing managers. Further, this 5 percent is less than the amount of new-mandate activity expected for international equity (defined as equity products that exclude the U.S.) or for multi-asset-class solutions (MACS).
Note, too, how the distinction between global and international equity plays out. International equity will see much more search activity than global equity (14 percent to 6 percent). But most of international equity’s searching will be replacement-driven.
Speaking of turnover
The consultants expect “modest turnover” for hedge funds and funds of funds. Twenty-two percent of the search activity affecting hedge funds will be directed at replacement. The corresponding figure of funds of hedge funds is 35 percent.
“While consultants do not expect hedge fund investing to cease,” the report tells us, investors therein “appear increasingly ready to fire poor managers.”
One important change is that defined benefit pension plans are “retreating toward passive mandates,” after disappointing experiences with actively managed portfolios. This follows from the LDI strategy mentioned above, and contrasts with development among endowments and foundations, where there continues to be a good deal of interest in active management.
In 2011, there were no pension consultants among those surveyed who expressed a “strong preference” for passive investments, and fewer than 20 percent of the pension consultants expressed a “moderate preference” for such investments. But in 2012, nearly 20 percent of that same group of consultants express a “strong preference” for passive over active and another 40 percent express a “moderate preference” in that direction.
Meanwhile, among endowment and foundation consultants, the shift from 2011 to 2012 has gone exactly the other way, as the above graph indicates.
Christopher Faille is a Jamesian pragmatist. William James has taught him, for example, that "you can say of a line that it runs east, or you can say that it runs west, and the line per se accepts both descriptions without rebelling at the inconsistency."