Institutional investors choose defensive allocations amid negative rates anxiety 

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Institutional investors are taking defensive positions into 2021, as they attempt to cushion portfolios against the long-term impact of the pandemic, including the fallout from government and central bank responses to the Covid-19 crisis.

According to a recent survey of institutional investors by Natixis Investment Managers, eight in ten institutional investors say markets have underestimated the long-term impact of the global pandemic. 

The prospect of negative interest rates is considered the biggest portfolio risk for the next year, with four out of five institutional investors saying low rates have already distorted market valuations.

In the UK, the Bank of England has kept its base rates at 0.1 per cent for eight months, but is considering taking rates negative in order to support economic activity and increase market liquidity. 

Other central banks including the European Central Bank, Swiss National Bank and the Bank of Japan, have already been using negative interest rate policies for several years.

The risk of interest rates falling even lower is mounting, with Fidelity International saying in a recent note that ever-easier monetary policy “likely to become structural, especially in developed markets”.

“As Covid-19 relief packages expire and to help mitigate the impact of a pending fiscal cliff, the Fed may also have to buy longer duration bonds, increase the pace of asset purchases and strengthen forward guidance. More easing is also likely in Europe given weaker growth and inflation expectations,” says Salman Ahmed, global head of Macro and Strategic Allocation at Fidelity.

Adrien Pichoud, chief economist at SYZ Group, also believes low rates will continue: “The European Central Bank is committed to purchase public and private bonds for the years to come. In the US, a divided Congress would put more reliance on the Federal Reserve to increase support and keep interest rates low for even longer. There is little reason to suppose then, absent a policy mistake, that any major economy will see a tightening in the currently ultra-accommodative financial conditions.”

According to Natixis’ survey, most institutional investors believe that the actions taken to quell the initial shock of coronavirus will have long repercussions, and over half said that policy decisions including rate cuts and fiscal stimulus provided by governments increased the risk of a financial crisis. 

In addition, more than half of Natixis’ survey respondents believe the volume of negative yielding securities will rise in the next year. 

The pension funds, endowment plans, and sovereign wealth funds surveyed favoured broad equity diversification and value over growth for the next year, and many said they plan to lower their exposure to government bonds.

“With the pandemic, politics and global economies at an inflection point, institutional investors are positioning their portfolios to navigate short-term volatility while anticipating the long-term impacts of this year’s massive economic and market interventions,” said David Giunta, CEO for the US at Natixis Investment Managers. 

According to Natixis’ survey, only 21 per cent of institutional investors expect a full economic recovery before 2022.

“Investors’ cautious outlook reflects deep concerns about the lasting consequences of the extreme measures needed to cushion the financial blow of the pandemic. However, they also see opportunities to find value through active management, thoughtful portfolio allocation and diversification,” adds Giunta.

In addition, 78 per cent of Institutional investors think the stock market’s current pace of growth is unsustainable, expecting performance in the year ahead to be hard-won and fragile.

Almost half believe a correction is due for the stock market, and to manage risks, eight in ten say that equity factor diversification is an important consideration. 

While 71 per cent of institutional investors say they are willing to underperform their peers to ensure downside protection, 53 per cent believe that defensive strategies will outperform a more aggressive approach in 2021.