Bye-Bye, Risk, Investors Want to Hit Goals

A new report from Principal Global Investors, “Asset Allocation: No Longer One Size Fits All,” highlights the latest investment themes pursued by four investor groups that account for around 80% of assets in the global investment universe. These include defined benefit (DB) plans, defined contribution (DC) plans, retail investors and high-net-worth investors.

As markets continue to defy some aspects of traditional investment logic, investors understandably remain cautious, the report says, leading to an increased demand for strategies tailored to take account of investor concerns and minimize unrewarded risk exposure.

“We are seeing investors operate with more caution,” says Barb McKenzie, senior executive director and chief operating officer of Principal Global Investors.

Baby Boomers are retreating from their previous risk-taking mode and now favor a high probability of certainty over a low probability of high returns, according to the report. McKenzie says this is backed up by Boomers’ selection of actively managed, income-producing funds. “Fewer and fewer investors are interested in tactically allocating through purely passive products today,” she says. “Beta is unpredictable, and investors crave predictability and income.”

The shift is not a short-term trend but the byproduct of a sustained low rate environment, the research says, and the change in attitude can be seen in the behavior of all four different investor groups.

DB plan investors that haven’t yet de-risked portfolios are turning toward liability-driven investing as they recognize that interest rates in developed economies are unlikely to increase dramatically for some time. Real assets and alternative credit structures are more prevalent because of their income and inflation protection characteristics.

DC investors continue to favor life-cycle funds thanks to their time-based, tailored approach. These funds support the goal of downside protection as they adjust to varying market conditions and the risk-appetite of investors at different times during the market and life cycle. Life-cycle funds also ensure that assets are rebalanced as market valuations move, guarding against the risk of buying high and selling low.

Retail investors are recalibrating their yield expectations in the face of sustained low interest rates, with many recognizing the benefits of dividend-paying stocks alongside more traditional income-producing bonds.

High-net-worth investors have moved away from a blanket focus on alpha to an emphasis on risk mitigation. These investors have become particularly cautious in developed markets and especially demanding in emerging markets in order to manage unrewarded risk. A preference for active management remains.

Key global trends in asset allocation and investor preference for certain asset classes that have developed between 2012 and 2014 include the following:

• DB investors – The popularity of real estate has increased by 26%, from 40% in 2012 to 66% in 2014, while infrastructure has experienced an equally significant increase of 23%, from 43% to 66%. The popularity of alternative credit has increased by nearly 20%, from 38% to 56%.

• DC investors –  Target-income funds recorded the largest increase in investor interest, growing from 34% use in 2012 to 56% in 2014. Target-risk funds saw an increase of 14%, from 36% to 50%. Target-date funds show an increase of 12%, from 52% to 64%.

• Retail investors – Funds with an income focus have become the most popular choice over the last two years with an increase in investor interest of 14%, from 48% in 2012 to 62% in 2014.

• High-net-worth investors – Real estate has become notably popular, showing an increase of nearly 25% in investor interest, from 37% in 2012 to 61% in 2014. Investors continue to prefer active management, with an increase of 25%, from 29% in 2012 to 54% in 2014.

One of the legacies of the 2008 economic crisis is the segmenting of the investor base as return expectations have dropped, the report says. If anything, ageing demographics have reinforced this trend. Investors can no longer be viewed as a generic group chasing high returns. That approach conceals more than it reveals, the report argues. It misses out on a new dynamic in asset allocation that is now firmly established. 

Under this dynamic, needs come before wants, liability matching before asset accumulating, and risk minimization before return maximization. The old style 60/40 equity-bond portfolio is fading into history, and like many other things, asset allocation is becoming more customized.

“Asset Allocation:  No Longer One Size Fits All” can be downloaded from The Principal’s website.