Institutions use alternatives to manage risk

January 02, 2018 09:07
Most institutions invest in alternative asset classes for diversification amid pronounced geopolitical tail risks. Photo: Reuters

More than two-thirds of respondents to our institutional RiskMonitor survey told us they invest in alternative asset classes, and nearly one-third said they use alternatives primarily for diversification – the most commonly cited driver.

Given the pronounced geopolitical tail risks present in today’s investment environment, this makes sense. Nearly three out of five investors we surveyed said that recent political events prompted them to enhance their focus on risk management, and more than two-thirds said the primary way they manage risk is by diversifying across asset classes.

Yet investing in alternatives also presents institutions with distinct challenges. Only about half of the global institutional investors we spoke with said they are able to measure effectively the risks posed by alternative assets.

This critical finding underscores the value that can be added by asset managers and financial intermediaries who can provide their clients with support and ongoing education. With 48 percent of investors saying they would invest more in alternatives if they could better manage and measure the risks, this presents a significant educational opportunity for the asset-management industry.

Taking the pulse of today’s institutional investors

These insights are from our RiskMonitor 2017 study of more than 750 institutional investors globally. In our report, we explore how increasing numbers of investors are using alternative assets to help manage risk and take action in the face of market uncertainty. Our goal is to highlight the experiences of those who invest in alternatives – including which strategies they use to seek specific outcomes – to build broader understanding of this asset class.

Diversification is key, but not the only reason to use alternatives

When we asked our survey participants about specific risk-management strategies, nearly one-third (31 percent) said diversification is the primary reason they invest in alternative assets. This is the highest consideration by some margin when compared with other drivers, including:

• Low correlations (19 percent)

• Potentially higher returns than conventional debt or equity investments (17 percent)

• Reducing overall portfolio volatility (11 percent)

The biggest proponents of alternative assets as diversifiers are endowments and foundations (38 percent), sovereign wealth funds (35 percent) and insurance investors (35 percent).

The use of alternatives as diversifiers demonstrates that investors sense the critical role these investments can play in managing risk in today’s environment. Diversification across asset classes (68 percent) and geographies (66 percent) are the most prevalent risk-management strategies used by institutional investors worldwide.

Yet diversification isn’t the only use for alternatives – an asset class that includes real estate equity, private corporate equity and debt, infrastructure equity and debt, relative value/arbitrage, macro strategies and more. Alternatives can also help generate absolute returns and have the potential to improve total portfolio outcomes through arbitrage and hedging strategies.

Investors need more insight into alternatives

Penetration levels of alternative investments are high – 70 percent of investors surveyed say they already invest in alternatives – and survey respondents told us they would consider investing even more if they had a greater understanding of this asset class.

We asked investors about the obstacles they face when implementing risk-management strategies. For more than a third of our respondents (38 percent), the difficulty of measuring the risk of alternative assets is an obstacle to implementing their chosen risk-management strategies.

Increased confidence among investors in alternatives

At the same time, investors were clear about the benefits they think alternatives provide – including, quite possibly, a stronger risk-management approach. We found that institutions that invest in alternatives believe they are better equipped to deal with investment risks. Nearly two-thirds (64 percent) say their organizations are well prepared to deal with investment risks, compared with 51 percent of investors with no alternatives allocation. This could indicate that investment in alternatives correlates with a greater confidence in risk management overall.

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As Global Strategist at Allianz Global Investors, Neil Dwane is responsible for presenting strategic house views and overseeing the Economics and Strategy Research teams.