As the bull market heads for its eighth year, investors are busy forecasting the performance of different asset classes in 2016. Economic woes in China, diverging international monetary policies, and a now definite – albeit slow-paced – rate hike have propelled market volatility to the forefront of investment concerns for the new year. Below is a summary of findings from a recent Natixis survey that outlines institutional investor predictions and portfolio rebalancing strategies for 2016.
Investment Goals and Sources of Market Volatility
Of the 660 global institutional investors that responded to the survey, 46% said their investment objective was to “achieve the highest possible risk-adjusted return,” while 42% stated that their primary goal is to “manage volatility in investment returns.”
The investors that were surveyed predict that the upcoming market volatility can be attributed to geopolitical turmoil (54%), economic trouble in China (49%), and the rate hike (47%). Interestingly enough, these top drivers of volatility are similar to those cited in a survey conducted by Natixis the previous year.
In recent events, the current U.S. presidential cycle, extensive news coverage of terrorist attacks, and China’s financial stimulus efforts are all factors that have the potential to trigger market volatility. While changing interest rates were speculated in previous years, the rate hike is now a reality. Investors are unsure what impact the slightest increase will have after a decade of stagnant rates, and as mentioned in a previous blog post, U.S. Treasuries – whose yields are sensitive to changes in the federal fund rate – might take a hit as prices fall in reaction to rising rates. Rate-sensitive stocks such as consumer staples and utilities have fared well in a low-yield environment thus far, but as rates rise, bonds may ultimately take precedence and drive down the value of these types of stocks.
Equities Expected to Perform Best, Bonds Worst
Despite this, 77% of the survey respondents believe equities will be the top-performing asset class next year. Natixis’ chief market strategist David Lafferty explains, “The institutional outlook for equities may not just be optimism for stocks so much as a commentary on the state of the bond markets.” Since interest rates are globally low and even negative in several European bond markets, many investors may prefer to allocate to stocks.
As such, bonds are expected to be the worst-performing assets of 2016, with 49% of respondents planning to decrease their weightings. When interest rates rise, 65% plan to opt out of longer-duration bonds in favor of those with shorter durations. Increasing allocations to alternatives such as private debt is another strategy investors intend to employ to cope with interest changes.
Increase Allocations to Alternative Investments
Average institutional portfolios allocate 42% to stocks, 28% to bonds, and 25% to alternative investments. In an effort to achieve non-correlated returns, mitigate market volatility, and decrease sensitivity to rate increases, 47% of the institutional investors surveyed plan to boost their allocations to alternative investment strategies such as private equity, private debt, and hedge funds. This is unsurprising given that alternatives have become an increasingly prevalent diversification technique among both institutional and individual investors seeking to enhance the risk-return profiles of their respective portfolios. Since alternatives are non-traditional investments, they do not tend to move in the direction of the stock market and naturally feature low correlations to traditional asset classes.
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