OPINION | Despite being located at the other end of the world, Australian institutional investors are not immune to the effects of geopolitical uncertainty and risk brought about by Brexit, Trump and Marine Le Pen’s surprise success in the first round of the French election. This is because the vast majority have exposure to global markets via funds domiciled and managed offshore.

At the same time, Australian institutional investors tell me their biggest risk by far is not geopolitical, but rather persistently low interest rates. The general consensus is that rates will be lower for longer, despite recent moves by the US Federal Reserve. This presents a real problem for super funds in particular: members heading into retirement need a yield they can live on, and that’s not easy to find.

So what can be done about it?

Some of the answers are revealed in Natixis’ Global Survey of Institutional Investors, which quizzed 500 of the world’s most influential stakeholders, including sovereign wealth funds and large corporate and government pension plans. The responses gathered in the survey show the willingness of institutional investors to embrace risk. Investment and allocation decisions are now being made with one eye on mitigating risks, and the other on exploiting risk for growth.

Australian institutional investors are telling me the same things. They are willing to embrace risk but, as ever, it’s all about finding the best risk/reward tradeoff.

Alternatives are growing in importance

Their international counterparts are attacking the problem through an increased exposure to alternatives, which they see as aiding in risk management, offsetting low yields and providing portfolios the stability that their traditional ballast, fixed interest, is now struggling to do.

The same is true of Australian institutions, which are increasingly interested in adding private equity and private debt, as well as managed futures, to their portfolios, all with the aim of diversifying away from equity risk. Again, this is in line with the thinking of their global counterparts, three-quarters of which stated that private debt and equity markets provide better risk-adjusted returns and diversification than fixed interest, and that they would happily invest more if there were more options.

The challenge for Australian institutions is finding the balance of risk, return, liquidity and fee levels. That is, while these kinds of funds and risk profiles are attractive for their higher returns, they do come at a higher cost in terms of fees.

Bank loans are one area attracting strong interest. Their risk/return profile is appealing, as they offer a good quality yield, immunise the investor from interest-rate risk, and are senior in the capital structure.

We are also seeing an increased allocation to real assets. Institutions are considering global direct property investment, for example, through unlisted offshore funds or in some cases individual mandates. We are seeing a desire for diversification away from Australian property, and a belief that the US property markets can provide a straight diversification play through quality core assets, whereas Europe is the place to look for value-add property sources, particularly in specialist areas such as logistics.

Active equity management is key

In terms of equities, long the mainstay of institutional investment portfolios, there is general consensus in Australia, and globally, that the current economic climate favours active management. The Natixis survey states that investors expect markets to become earnings driven, rather than relying on the sugar high of accommodative monetary policy, which means true active management should outperform.

My experience is that institutional investors favour active equity management but want a manager with high active share. Experience shows that active managers do often outperform, but the trade-off can be higher fees. So institutions want to see the demonstrable value.

Managing risk in volatile times is the overarching concern, combined with an acceptance that in a low-yield world, shying away from risk is not an option. Instead, the name of the game is to put risk first.

Kevin Haran is the executive managing director of Natixis Global Asset Management in Australia.

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