Passive Investments Increase Systemic Risks

A majority of institutional investors believes that the popularity of passive investments has increased systemic risk, a survey by Natixis Investment Managers reveals.

A survey of 500 global institutional investors reveals that two-thirds are concerned by the impact that passive instruments have on market risk and asset pricing. In the latest Natixis Investment Managers survey, 61 percent (58 percent in Asia) highlighted that flows into passive strategies have artificially suppressed volatility. More than half (42 percent in Asia) of those surveyed also think passive investing has distorted relative stock prices and risk-return trade-offs. 

«We believe that over time, passives will pose huge concentration risk, which could lead to systemic risk and see them truly tested when the next market downturn happens,» said Oliver Bilal, head of international sales at Natixis Investment Managers.

Demand For Passives Plateauing

Against this backdrop, investors are also slowing down the rate by which they plan to increase their exposure to passive strategies, with institutions appearing to have found the sweet spot in allocations. «Institutional investors seem to have found their optimum allocation between active and passive, and we are now starting to see a slowdown in the growth of allocation to passives,» said Bilal.

Three years ago, institutional investors had anticipated increasing passive holdings to as much as 43 percent within three years.  Fast forward to 2018, respondents have given no indication of making significant changes to their current allocation of 70 percent active and 30 percent passive over the next three years (same in Asia).

Preference For Active Management

Institutional investors are also expressing a preference for active management ahead of anticipated market volatility in 2019, with four in five expecting to see increased market volatility over the next year.

The same proportion of surveyed investors (77% in Asia) suggest the current market environment will favour active portfolio management. Investors remain optimistic about returns but have slightly lowered the average return assumption for the year to 6.7% (7% in Asia), versus 7.2% in 2017.

Closet Trackers Need to Be Exposed

While the majority of investors believe the market environment is optimal for active investing, active managers must clearly evidence their value, to distinguish themselves from «closet trackers», or active fund managers tracking holdings within indices.

However, if the industry can expose closet trackers, then two thirds (66% and 58% in Asia) of investors think this will ultimately benefit those managers who follow a truly active approach. The majority also believe such managers will outperform over the long term.

«Appetite for active strategies is a clear indication that in times of market turbulence, institutional investors want a skilled professional at the helm. However, expected increased market volatility and a more challenging environment for generating yield means there will be a widening distinction between managers who can generate alpha,» said Bilal