Basic Assumptions Have Changed for Institutional Investors

Data provided by Willis Towers Watson (WTW) about the firm’s broad base of institutional investor clients offers a telling look at the wider marketplace in which defined contribution (DC) and defined benefit (DB) plans operate.

WTW serves pension funds, sovereign wealth funds, endowments, foundations and insurance companies. This group of large-scale investors, according to the firm, “increased their level of investment by almost 20% in 2016,” making new selections across different asset classes and “covering allocations made on both an advisory and delegated basis.”

Of course this represents a business win for WTW, but it is more important to observe how the client base itself has fully committed to preparing for the long-term financial future. There is a new understanding that “what worked for investors in the past is unlikely to work in the future,” suggests Brad Morrow, head of manager research in North America with Willis Towers Watson. “So our clients are looking for new, innovative ways to achieve better risk-adjusted returns.”

Morrow describes this as “finding ways to work their assets harder.”

“That is at the top of our clients’ agendas, be it through reducing costs, adding diversity or creating bespoke solutions in a much more thoughtful way than in the past.” Morrow says.

Data provided by the firm suggests equities remained the most popular asset class in 2016, with total equity investment made jumping 25% above what was measured in 2015. Private equity selections jumped 75%, Morrow notes, “but there was also a general increase across other equity strategies such as active global equities, emerging markets and equity smart beta.”

NEXT: Adding skill and illiquidity 

Many money managers have seen similar patterns. As Morrow describes it, “the attractiveness of adding skill and illiquidity return drivers has increased.” He warns that utilizing these asset classes successfully “requires more effort from investors.”

“Most active managers do not add value after fees,” he adds, “so the way to achieve success is by accessing skill through concentrated best-in-class portfolios, relentless cost management and using smart beta where appropriate to complement equity exposure.” 

Other key stats show investors moving into “diversifying strategies.” The number of selections in infrastructure and real estate increased by nearly 50% for the 12-month period ending December 31, 2016. Liquid multi-asset strategies also saw more than 70% growth during this period, WTW reports.

“Activity was meaningfully lower in some parts of the credit market, such as developed-market government and investment-grade corporate bonds, reflecting the valuation picture in the current state of significant monetary expansion,” Morrow concludes. “However, the credit universe is very wide, and there is scope to retain exposure to the credit risk premium through alternative forms of credit while at the same time introducing more illiquidity and skill in these less efficient areas.”

NEXT:  Other firms have a similar take 

During a recent conversation with PLANADVISER, Todd Cassler, president of institutional distribution for John Hancock, offered a very similar outlook regarding his own firm and its many clients and franchises. He very candidly suggested John Hancock Investments, like so many other diversified traditional providers with extensive and well-established distribution channels, is coming to rethink its identity for the new consumer age.

“We provide asset allocation solutions, manager selection research, beta/indexing and a number of other core competencies, and we have made a significant commitment to open architecture,” Cassler says. “One of the keys to remaining successful into the future is thinking of new and very clear and understandable ways to package these services. We must be able to respond to the particular needs of our different clients.”

In particular Cassler, believes the push into open architecture will be crucial in the decade ahead. This is not exactly a surprising position given his firm’s approach, but he does make some convincing arguments.

“More than 50% of all plans and nearly 70% of small plans still offer closed-architecture target-date funds run by their recordkeepers,” he observes. “This is despite the fact that we know that no single provider can be the best at everything, at every asset class, nor can they even remain the best in a single category forever.”

Cassler suggests clients generally react very positively to the idea of utilizing a multi-manager approach for the target-date fund, “and all the indications are that it will be increasingly difficult to operate in a bundled environment.” He concludes, like Morrow, that fees “have moved from the third- or fourth-most important consideration for institutional client to clearly be the first.” 

"Remarkably, for some investors it even seems that fees are outweighing net performance," he concludes. "It will be a challenge and an opportunity for John Hancock and other firms to work in such an environment."