Risk adversity, manager doubt still reign

Wednesday, October 13, 2010 Stamford, CT USA — European institutional investors emerged from the worst days of the global market crisis with a diminished tolerance for risk and serious doubts about the ability of their investment managers to deliver value through active management. Rather than fading as markets returned to a more normal footing, these altered perceptions seem to be taking root, as evidenced by the increasingly conservative investment strategies currently in place among European institutions.

In the first half of 2010, Greenwich Associates interviewed representatives of 381 of the largest institutions in Continental Europe. In these conversations, participating institutions made it clear that their primary concerns for the remainder of this year involved risk management, asset protection, complying with new regulations, and monitoring a burgeoning government debt crisis that seemed to pose a risk to the nascent economic recovery. Although institutions also expressed concerns about generating higher levels of investment returns or alpha, this topic received much less mention.

In general, European Institutions are sticking with fixed income rather than moving assets back into equities. "Institutions are aware of the need to achieve higher levels of returns in order to fund long-term liabilities or otherwise meet their obligations. However, in light of the regulatory framework many have to comply with and a further decreased risk appetite, they do not see a better alternative to their current conservative, fixed income-oriented allocations, thus further deferring substantial changes of their asset allocation," explains Greenwich Associates consultant Tobias Miarka.

Institutions Stick With Fixed Income
Assets under management (AUM) by institutions in Continental Europe increased 18% from 2009 to 2010. (AUM figures are based on information provided by a matched sample of institutions participating in Greenwich Associates research in both 2009 and 2010). The gradual recovery in AUM was largely consistent across all of Continental Europe's regional and country markets and in some countries portfolio assets have begun to approach pre-crisis levels.

Virtually all the growth in institutional portfolios from 2009 to 2010 can be attributed to appreciation of asset valuations in step with a strong recovery in global financial markets. However, during a 12-month period of strong performance in European and global stock markets, equity allocations within European institutional portfolios increased by only about one and a half percentage points, growing from 17.8% of total assets in 2009 to 19.4% in 2010. Allocations to European equities actually decreased to 11.3% in 2010 from 12.1% in 2009, while international equity allocations increased to 8.1% from 5.7%.

In light of the relatively small increase in equity allocations it is clear that European institutions are not moving to rebuild equity allocations that were reduced during the crisis. Over the same period, allocations to European bonds increased to approximately 57% of total assets from 52%.

As always, institutional allocations vary considerably from country to country across Europe. In France and Belgium, fixed-income investments represent two-thirds of institutional assets, with equities making up only at about 20%. At the other extreme, Swedish institutions allocate approximately 35% of assets to fixed income, with equities making up almost 45%.

Expected Changes to Asset Mix
There is no doubt that institutions consider themselves over-exposed to European bonds. On average, institutions have a target allocation of 20.2% of total assets for European government bonds; current allocations stand at 23.6%. Targets for European corporate bonds average 17.0%; current allocations average 19.7%. "Don't expect assets to flow into equities as institutions rebalance back to their targets," advises Greenwich Associates consultant Marc Haynes. "At 10.1% of total assets, current allocations to active European equities are only 120 basis points shy of target. Institutions are slightly above their target allocations to international equities and are even with targets for passive European equities."

As in past years, European institutions indicate they do indeed plan to reduce allocations to European fixed income and to increase allocations to international bonds and to equities, especially internationally. "It is important to note, however, that institutions have been expressing this intention regularly for some years now, but have consistently failed to achieve this goal," says Tobias Miarka. "Given the stricter regulations and the current, conservative mindset, we consider it unlikely that institutions will shift assets out of European bonds in any meaningful way in the coming months."

Institutions that elect to reduce allocations to active European bonds are more likely to move freed-up assets to passive European fixed income. Current allocations of 9.6% fall far short of the 13.3% target allocation institutions have set for passive European bonds. "Large institutions in particular seem to have developed a larger appetite for passively managed strategies," says Greenwich Associates consultant Chris McNickle.

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