By Angele Paris – As macro-economic forces and the current market environment push institutional investors to look beyond their traditional asset class comfort zones, multi-affiliate asset manager Carillon speaks of the growing attraction of unconstrained strategies, the need for flexibility and the importance of considering the opportunities available despite the negative background.
Institutional investors in Europe have a long history of allocating heavily to fixed income but the low interest rate environment together with political and economic uncertainty has left these investments on shaky ground.
“Fixed income is such an important part of European institutions’ investment mentalities,” says Cooper Abbott chairman and president of Carillon Tower Advisers, “if the negative interest rates stay with us for a while, then that’s going to require a bit of a re-think. Lower rates decrease investment income relative to liabilities from an LDI standpoint and hinder the investors from meeting their obligations from a cashflow standpoint.”
Research and analysis have shown that a prolonged period of low rates can have a significant impact on the profitability and strength of the financial sector. Further, investors should be wary of potentially making themselves vulnerable by responding to low interest rates and increasing their risk taking beyond a level they are comfortable with.
With market commentators predicting a recession in the near future, as de-globalisation and decoupling of the global economy start to reveal themselves, it follows that institutional investors are preparing for a rocky time. But according to Abbott, investors are bracing themselves too tightly and as a result, could be missing out on ripe investment opportunities.
“The macro-economic environment is a challenge given where we are in the cycle,” he says, “However, there is too much focus on risk and not enough on opportunity in this particular moment.”
According to Abbott, it is unlikely that next recession will be as harsh that of 2008. “But investors are reflecting back to that emotionally or instinctually. Although it’s quite likely we’ll see a recession, it doesn’t have to be as extreme. If people take a longer term perspective on their investment horizon then there is money to be made in this kind of environment.”
Although institutions are inherently long-term investors, they face short-term pressures which can sometimes deviate their focus. Cash-flow concerns and the need to report annual returns are two of the most quoted challenges they face in keeping long-term objectives in their sights. Defined benefit schemes, in particular, remain under consistent pressure following significant losses as a result of the fall in stock values at the end of last year.
However, despite these difficulties, there are several pockets of the market in which institutions can take advantage of the current cycle, to the benefit of their long-term interests.
Given the current environment, Abbott says institutional investors are being drawn to more unconstrained, go-anywhere fixed income strategies. “The interest rate fluctuations in the last six months alone are proof of extreme uncertainty around the next move from central banks, which is very challenging due to the long-term objectives institutional investors are aiming to fulfil,” he says.
“Therefore, we are seeing the expansion of unconstrained bond investing. Rather than having set benchmarks, institutional investors are being more opportunistic and responding to the changing market dynamic,” Abbott continues.
An unconstrained approach to fixed income could lead institutional investors to the territory of leveraged loans and collateralised loan obligations. This is where their awareness of risk needs to be heightened. In its Financial Stability Report, released in June 2019, the European Insurance and Occupational Pensions Authority notes that the volume of CLOs traded has risen substantially. “If market conditions worsen, CLOs could lose their trading liquidity,” the report says, following on by explaining the risks these assets could pose in more detail.
But institutional investors can spread their risk exposure and in view of this, Abbott identified growth in income strategies which are position agnostic. These are offerings of a combination of equity and fixed income with general guidelines and the ability to invest in any part of a chosen company. “Its about having x-ray vision into the company and finding where the greatest value lies, how the growth is being generated and how they’re taking advantage of the current low rates,” says Abbott.
The Carillon president says the negative environment can inspire change. “Asset managers can lead a change in philosophy. Too much of asset management is product pushing and developing strategies and putting packages to market without consideration of what the end user might find most beneficial.
“We want to be partners with our investors and clients. They might hire us for a particular strategy, but we want to have discussions with them across a range of asset classes – even those they didn’t initially hire us for. We believe we’re able to add value and help them think through what their overall portfolio can look like,” says Abbott.