A Look Ahead to 2021: Institutional Investors Brace for a Bumpy Road

Investors around the world are concerned that the markets are poised for troubles ahead. So they are planning defensive strategies for their portfolios as they look to 2021, according to a Natixis survey.

The broad majority of institutional investors believe the global economy has yet to reckon with the consequences of COVID-19, according to a Tuesday report. Eight out of 10 allocators believe gross domestic product (GDP) levels will not return to pre-COVID-19 levels until 2022 at the earliest.

Market and sector corrections are on the horizon, investors say. Four out of 10 investors believe the stock market, real estate sector, technology sector, or cryptocurrency will suffer drawdowns in 2021, while another 20% to 30% of investors say bonds, initial public offerings (IPOs), and special-purpose acquisition companies (SPACs) will encounter corrections.

In response, more than half of investors (53%) are planning to take a defensive stance, while 47% plan to use aggressive strategies. About a third of investors expect hedge funds will help manage risk, versus better returns, in their portfolios. Eight out of 10 investors say equity factor diversification is important to consider.

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Allocators don’t plan to change their asset allocations, but they do want to rearrange investments within them. In equities, which investors expect will remain a 36% allocation in their portfolios, about a third of investors are expecting to decrease exposure to US equities in 2021 in favor of European, emerging market, and Asia Pacific stocks.

In fixed income, an expected 40% average allocation in portfolios, some investors expect they will focus more on investment grade corporate debt, securities debt, and green bonds next year.

In alternatives, investors will slightly dial up portfolio allocations to 17% from 16%, and many expect that they will increase exposure to private debt, infrastructure, and private equity.

As private assets continue to grow in significance in investor portfolios, institutional investors agree that they will play the role of a safe haven in the event of a correction, the report said. But other concerns remain for the asset class, such as liquidity risk and too much money chasing too few deals.

About 500 institutional investors at corporate and public pension funds, endowments and foundations, and sovereign wealth funds were surveyed for the Natixis Investment Managers report in October and November.

Respondents came from North America, Latin America, the United Kingdom, Europe, Asia, and the Middle East.

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The funded status of the 100 largest corporate defined benefit (DB) pension plans rose $12 billion during November thanks to an impressive 5.03% monthly investment gain, as their funded ratio increased to 86.2% from 85.2% at the end of October.

The aggregate deficit of the plans, as measured by the Milliman 100 Pension Funding Index (PFI), narrowed to $272 billion as the market value of the assets gained $77 billion during the month to end November at $1.707 trillion. Despite the improvement, corporate pensions are still down for the year with an $89 billion drop in funded status.

“November’s market returns were the highest gains of 2020 so far, but the low discount rate environment continues to be a drag on funding,” Zorast Wadia, author of the Milliman 100 PFI, said in a statement. “It would likely take both another stellar investment month, along with a significant discount rate increase, to end the year up from 2019.”

After three consecutive months of increases, the benchmark corporate bond interest rates that are used to value pension liabilities fell 24 basis points (bps) in November to 2.47% from 2.71% in October. As a result, the projected benefit obligation increased $65 billion during the month, raising the Milliman 100 PFI value to $1.980 trillion from $1.915 trillion at the end of October. Despite recent increases in discount rates, Milliman said they continue to rank among the lowest ever recorded in the 20-year history of the PFI.

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Milliman also said that despite having a cumulative asset return of 11.15% for the 12 months to the end of November, the funded status deficit of pensions in the index worsened by $45 billion during that time, as the funded ratio of plans declined from 87.6% in November 2019.

Milliman forecasts that if the plans in the index were to earn the expected median asset return of 6.5%, and if the current discount rate of 2.47% were maintained through the end of 2022, their funded ratio would rise to 90.4% by the end of 2021 and 94.6% by the end of 2022. This is under the assumption that aggregate annual contributions for 2021 and 2022 will be $50 billion.

The firm also said that under an optimistic forecast in which interest rates rise to 3.12% by the end of 2021 and 3.72% by the end of 2022 with annual asset gains of 10.5%, the funded ratio would surge to 103% by the end of 2021 and 121% by the end of 2022. However, under a pessimistic forecast that has the discount rate at 1.82% by the end of 2021 and 1.22% by the end of 2022 with 2.5% annual investment returns, the funded ratio would fall to 79% by the end of 2021 and 73% by the end of 2022.