The Top Five Institutional Investor Themes For 2011

Investing over inter-generational time horizons is both a daunting responsibility as well as a liberating reality for institutional investors.

On the positive side, pensions, endowments and foundations can invest for the long-term freed from the conventions of quarterly reporting and the market’s obsession with short-term performance. In this context a ‘Top 5 Investment Themes’ list is another attempt to shamelessly exploit short-term thinking.

That said, I was so underwhelmed with the circa 2008 Top 5 Alternative Investment Trends for 2011 list published by last week that I wanted to put forth an alternative list that I will flesh out further over the next few weeks. 

1. Increasing allocations to real assets 

 The debate over the outlook for inflation and how to measure it continues to rage. Nonetheless, consensus expectations (say as represented by break-evens on the 5yr) are that inflationary pressures are on the rise. Expect to see institutional investors continue to expand their real assets programs. The larger investors will of course continue to invest directly in large-scale infrastructure and real estate projects.

2. Further de-risking of traditional equity portfolios

Several large endowments and pensions started re-thinking their massive equity exposures in 2007. The events of 2008/09 clearly accelerated this trend. As public and private pension plans come under ever increasing pressure to correct funding levels, hedge funds will continue to see increased flows, and investors will continue to implement tail-hedging programs.

Investors will continue to be attracted by the liquidity, diversification and downside protection offered by HF Funding Solutions. Look for increased flows to the top-tier fund of hedge funds (Blackstone, Grosvenor, Permal etc).

3. Continuing innovation in access routes

With drawdowns threatening contributions to operating budgets and endowment spending policies and pensions suffering from portfolio and political pressure to correct funding levels, institutional investors have been forced to change the structure of their investment teams and approach. This in part has also impacted the routes preferred by investors to access underlying investment exposures.

Several large investors have reduced the size of their investment teams, others have moved to a partial or full outsource CIO model. Strategic partnerships have and will continue to flourish. Meanwhile traditional asset managers are building out alternatives capabilities and alternatives shops are increasingly branching out in the long-only world. Institutional investors will increase their buying of ETFs to implement policy allocations and pressure asset managers to bring down pricing and increase reporting on managed accounts.

4. Further industry shake-out and the renaissance of smaller managers

Much has been written about a barbell developing in the hedge fund industry with very large, established managers on one end and small, niche, emerging managers on the other. The middle-market will – it is often argued – be unable to compete and be squeezed out.

I think we will start to see the emergence of a new paradigm over the next 5 years. The larger managers will come under increasing pressure as their size impacts performance, attracts the attention of regulators and business owners force change to business models and structures ensuring alignment of interest with investors.

Smaller, more niche HF managers will flourish for two main reasons. Firstly investors will continue to be attracted by uncorrelated strategies and the alpha offered by emerging managers in niche and developing market segments. Secondly the first vintage of post-2008 hedge fund managers with institutionalized business models is emerging. Look for the continuing development of innovative seeding platforms/ businesses.

5. Increasing importance of ESG

Institutional investors and their investment consultants will continue to work together to further institutionalize the asset management marketplace.

ESG is becoming an increasingly important consideration for institutional investors. As funding levels improve and the broader economy continues to stabilise, expect to hear a growing chorus reciting the merits of investing within a sustainable framework.

As investors continue to grapple with the changing structure and dynamics of the markets as well as their own asset allocations, investment approaches and processes, they will rely increasingly on their consultants and investment partners for genuine thought leadership addressing the issues they are facing.