Institutional Investors: Bonds Back, Crypto Out, More Volatility Ahead

Given expectations of higher interest rates, inflation and volatility, institutional investors enter 2023 with a gloomy view of the economy, but they do still see opportunities in the market, according to new survey findings. 

Natixis Investment Managers (Natixis IM) surveyed 500 institutional investors who collectively manage more than $20 trillion in assets for public and private pensions, insurers, foundations, endowments and sovereign wealth funds around the world. 

It found that the vast majority (85%) believe the economy “is or will be” in a recession next year, which 54% think is necessary to get inflation under control. However, most (65%) institutions think the bigger risk ahead is stagflation, or a period of negative GDP growth with entrenched inflation and increasing unemployment. 

The survey also found that 53% of institutional investors are actively de-risking their portfolios with “tactical allocation moves” to fixed income and resourceful use of alternative strategies for higher yields, stable returns and a hedge against downside risks. 

“Even though many institutional investors say a recession is inevitable, they still see opportunities in the market, especially in fixed income,” notes Liana Magner, Executive Vice President and Head of Retirement and Institutional for Natixis IM in the U.S. “However, it’s no surprise that with top risks that include war, inflation, interest rates and monetary policy errors, 74% of institutions believe the markets will favor active managers in 2023, especially since the majority say their active investments have outperformed in 2022.” 

According to the findings, institutional investors’ view on the markets for next year include the following: 

• They are most bullish on private equity (63%) and are split between bulls and bears on their outlook for stocks and private debt. 
• 72% think rising rates will usher in a resurgence of traditional fixed income, and their outlook on the bond market next year is mostly bullish (56%). 
• 60% think large-cap stocks will outperform small caps, and outperformance will most likely come from the healthcare, energy and financial sectors. 
• 61% agree that ongoing remote work will result in a sharp depreciation of commercial real estate assets; they remain committed, however, to real estate and are investing in non-traditional or thematic-driven spaces, especially data centers and senior, student and affordable housing. 
• 69% agree that valuations still do not reflect fundamentals, but 72% think the markets will finally come to terms next year with the realization that valuations matter. 
• 57% expect stock volatility to rise while 64% expect bond volatility to settle down; an exception is in Asia where 46% expect increased volatility in bond prices.  
• 62% expect developed markets to outperform emerging markets. 
• 76% expect gold to outperform cryptocurrency. Moreover, 83% agree that blockchain technology is the “real revolution” anyway, not cryptocurrencies. 

Portfolio Moves 

Regarding portfolio moves, more than two-thirds (67%) of institutional investors think that actively managed funds will outperform passive, and that portfolios with a mix of stocks, bonds and alternative strategies will outperform those with a traditional 60/40 mix of traditional stocks and bonds. While they are planning to shift allocations by no more than 1% to or from any asset class, institutional investors are making notable tactical changes, the report notes. 

Within equities, institutional investors are most likely to increase allocations to U.S. stocks (40%) followed by Asia-Pacific (31%) and emerging market (32%) stocks. 

Within fixed income, nearly half (48%) are increasing allocations to government bonds and 49% plan to increase allocations to investment grade bonds. Moreover, 63% say they will look to short-term bond ETFs to counter duration risk. 

In emerging markets, they see the best growth opportunities in Asia ex-China. Two-thirds (66%) agree that emerging markets are overly dependent on China, and 74% think China’s geopolitical ambitions have reduced its investment appeal. 

Within alternatives, institutions are most likely to increase allocations to private equity (43%), where they see energy, information technology and infrastructure investments as most attractive. 

Additionally, 62% believe there is alpha to be found in ESG investments, and 59% plan to increase their ESG allocations. Fully half (50%) plan to increase allocations to green bonds, including 68% in Asia, 54% in EMEA and 51% in the UK, but only 25% in North America. 

Natixis IM’s survey was conducted in October and November 2022 by CoreData Research, among 500 institutional investors in 29 countries throughout North America, Latin America, the United Kingdom, Continental Europe, Asia and the Middle East.