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Addressing Clients’ Portfolio Risk in a Volatile Market

Mutual Funds

Fund selectors see interest rate hikes, inflation, valuations and volatility as among the growing list of portfolio risks as they look to manage investments and client emotions, a new survey reveals. 

According to findings by Natixis Investment Managers, 80% of the investment managers say that investors have taken on too much portfolio risk in a rate environment that has distorted stock values and decimated bond yields. Fund selectors also expect more volatility for the stock market (78%) and bond market (72%), and 67% say more frequent rebalancing will be important as markets churn. 

Natixis IM surveyed 141 U.S. investment professionals who collectively represent $2.7 trillion in client AUM and are responsible for selecting the products and strategies, including mutual funds and exchange-traded funds (ETFs), used to create client portfolios on wealth manager, private bank, family office, wirehouse/broker-dealer, retirement plan provider, insurance and other retail investing platforms. The U.S. findings described below are part of a larger global study of 436 professional fund selectors in 25 countries representing $12.6 trillion in client assets conducted in December 2021. 

The survey shows that fund selectors are mostly confident in the resilience of the U.S. economy and strength of American consumers. However, they see supply chain disruptions—which 62% expect will continue until 2023—as the biggest potential threat to the U.S. economy, followed by relations between the U.S. and China (43%). On a macro level, they are less concerned about the economy’s ability to weather tightening monetary policy (35%), government spending (34%) and COVID variants (31%). 

And despite the ongoing surge in Omicron, 61% of fund selectors don’t expect new variants to slow economic growth this year. Yet fund selectors see increased risks for investment portfolios, which have thrived in a market lifted by unprecedented fiscal and monetary stimulus. The survey found:

  • 85% of fund selectors believe valuations are distorted by low rates and do not reflect company fundamentals (66%);
  • 72% think the stock market has grown at a rate that is not sustainable; and
  • their top portfolio risk concerns are now rates (77%), inflation (77%), valuations (53%) and volatility (52%).

Positioning Portfolios

U.S. fund selectors see opportunities for growth this year in a market environment that 73% agree will favor more active management and 67% say more frequent rebalancing will be important in the current market. And despite changes in economic factors that shape market assumptions, fund selectors anticipate no dramatic shifts in allocation strategy. On performance, fund selectors forecast the following as most likely in 2022:

  • They expect better returns on the reopening trade (70%) than the stay-at-home trade (30%); value (66%) over growth (34%); and by a narrower margin, small cap (55%) over large cap (45%).
  • Most (70%) think Big Tech will continue to grow unabated.
  • They recommend tactical rotations to more economically sensitive and value-oriented sectors. 
  • They are divided on whether growth is more likely to come from developed markets (51%) or emerging markets (49%); however, 78% agree that emerging market investments are overly dependent on China, and 87% feel that regulatory uncertainties in China make the country a less attractive investment opportunity.
  • They remain committed to the role fixed income plays in client portfolios, although 87% agree it will be important to counter duration risk as rates begin to normalize. With rates still at historically low levels, 69% are increasingly recommending alternative strategies as a way to generate yield.

Models, Alternatives and ESG

Fund selectors are also focused on enhancing their product offering as they look to balance a changing investment landscape with the evolving needs and interests of clients, the study notes. 

At the core of this offering are model portfolios aligned with clients’ preferences and risk profiles. On average, three-quarters of the models currently on fund selectors’ platforms are proprietary models; however, 42% say they intend to add more third-party models this year, and 45% plan to increase the number of actively managed funds offered.

“Given concerns about increased volatility, fund selectors are clearly telling us that model portfolios are likely to take a prominent place in plans for 2022 as they look to present an integrated, risk-based solution that can help investors navigate a riskier market environment,” notes Dave Goodsell, Executive Director of Natixis IM’s Center for Investor Insight. “At the same time, many are looking to complement their core model offering with non-correlated investments and other specialized strategies.”

Over the next two years, fund selectors say they plan to add:

  • Model portfolios: 87% will enhance their model portfolio offering, including adding models focused on tax management (49%), alternatives (41%), income generation (39%), ESG (37%) and thematic areas such as disruptive technologies and longevity (31%).
  • ESG investments: Nearly 6 in 10 (59%) are adding more ESG-focused investment options. While half of fund selectors say consideration of ESG factors is an integral part of sound investing, slightly more than half (52%) believe there is alpha to be found in ESG investments.
  • Private assets: Half will add more private investments, where 72% of fund selectors say there is a significant delta in returns from the public markets. They see the most attractive areas for private equity investments as information technology, infrastructure, health care and real estate.

Cryptocurrency Conundrum

Meanwhile, 40% of fund selectors report that clients are increasingly demanding cryptocurrency solutions, and 45% feel pressure to add cryptocurrencies specifically to appeal to younger investors.

Of those currently offering digital currencies (45% of all respondents), 45% intend to further expand their existing offering. However, most fund selectors (68%), for now, do not believe individual investors should have exposure to cryptocurrency. Nearly 9 in 10 (87%) agree that these assets need to be more transparent, and 84% think they will need some type of regulatory oversight. Moreover, 70% say their firm needs more education in digital assets and cryptocurrencies before investing in them.