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Recession did not substantially alter institutional investment strategies

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Despite the economic recession and tumults in the stock market, The Conference Board has found that all major categories of institutional investors have remained fundamentally committed to the same investment policies they were adopting prior to the credit crunch.

The Conference Board Institutional Investment Report, which is released annually in the autumn, analyses the asset growth and portfolio composition of institutional investors operating in the US.

"For decades, institutional investors had been shifting their allocation preferences from fixed-income securities into equity," says Matteo Tonello, associate director of corporate governance at The Conference Board and co-author of the publication. "Then last year came, and it had a devastating effect on institutions’ expanded equity portfolios."

By the end of 2008, institutions had only 36.6 per cent of their assets in equities, down from 47.2 per cent at the end of 2007.

"And yet these revisions appear to have been driven by market declines rather than by changes in investment policies," says Tonello.

At the end of 2008, when measured as a percentage of outstanding US financial assets, institutional assets had reached their lowest level since 1980, or 15.8 per cent. The industry reported substantial losses across virtually all asset classes, with total institutional assets plunging 21.3 per cent to USD22,251.7bn, a level similar to what was recorded in 2004.

Mutual funds and other investment companies, which had seen the fastest growth in the last few decades, were hit the hardest by the recent market decline and capital withdrawals, with outflows totaling USD2,503.5bn for the year, or 30.7 per cent of their 2007 asset value. By comparison, pension funds lost 24.1 per cent of their 2007 asset value whereas insurance companies experienced a 7.8 per cent contraction.

Declines in capitalization occurred fairly evenly across the institutional investor spectrum, without significant changes to the share of total institutional assets held by type of institution. Today, pension funds were still the leading category, holding 38.6 per cent of total institutional assets.

Over the decades, mutual funds have grown into the investor category with the highest exposure to equity. At the close of 2008, as a result of stock market correction and the 45 per cent median loss suffered by their equity portfolios, mutual funds were reporting much more balanced asset allocations.

According to the report, insurance companies have lower exposure to stock and, not surprisingly, their asset allocation was the least affected by the market plunge. The property/casualty segment, in particular, reported asset distributions substantially identical to those of prior years, when investments in equities were never increased to the level that preceded the US recession of 2001-2002.

Over the last 20 years, institutional investors have steadily expanded their presence in the stock ledger of the largest 1,000 corporations. Despite the significant repercussions of the recent market declines on their equity portfolio, institutions still own a large majority of top American businesses.

At the end of 2008, when measured as a percentage of outstanding US bonds, institutional bonds had reached their lowest level in the last decade, or 23.7 per cent. By comparison, at the end of the 2001-2002 recession, institutions were still holding as much as 27 per cent of total outstanding equities. However, by the end of 2008, the total market value of the fixed-income portfolio of institutional investors was substantially unchanged from the prior year. Variations in bond allocations registered for some categories were driven by the decline of the stock market rather than changes in investment policies.

Overall, despite the recent correction, institutional investors remain committed to alternative investment strategies. The large asset manager foray into hedge funds appears to be the result of a number of factors, including the need to pursue higher returns and reduce volatility to meet actuarial projections, and the competitiveness of traditional investment strategies in stocks and bonds. However, the value of alternative asset classes, which often lack public quotations, may not yet fully reflect the losses of the public market, says The Conference Board.

Mutual funds remain major investors in non-US securities, driven by the growing demand for diversification of household savings. In 2008, total assets held in foreign securities by the 25 pension funds with largest foreign allocations amounted to USD206,920m, compared to USD210,320m of total equities held by the 20 largest mutual funds focusing on international investment strategies.

The dominance of mutual funds in foreign financial markets helps explain the severe contraction of investments in non-US securities that was registered in 2008, the report says. At the end of the year, total equity held by the 20 largest actively managed funds operating in the international market was down 36.3 per cent from the prior year.

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