European asset owners are adding risk back into their portfolios under the expectation that the spread of COVID-19 will slow during the summer.
As European countries are easing travel restrictions and governments and central banks have stepped up monetary and fiscal support, investors are looking for opportunities to take on more risk.
Still, with the specter of a second wave of infections that could spark another equity market shock later in the year, European investors are taking different approaches to how they are adjusting risk in their portfolios, sources said. Some of them now feel they are compensated for default risk and are boosting investment-grade, high-yield and distressed debt exposures, consultants said. Other investors have increased or are looking to increase their small-cap equity, listed and unlisted infrastructure, and real estate exposures by adding back risk that they removed when the coronavirus started wreaking havoc on markets.
In market dislocations, investors can pop outside of their usual risk exposure targets across all asset classes by accident or because they don't believe they are compensated for the risk they are taking, said Sorca Kelly-Scholte, Europe, Middle East and Africa head of pension solutions and advisory at J.P. Morgan Asset Management Ltd in London.
"People could not see how they can get paid for the credit risk or emerging markets strategies (as the crisis went on) and they decided to hold off. Now, people are stepping into credit dislocation strategies as yields have broadened," she said.
The impact of negative investment returns in the first quarter is also making investors reconsider their risk exposures. In the U.K., defined benefit plans on average experienced a 6.3-percentage-point fall in funding levels in the first four months of the year, Ms. Kelly-Scholte noted. It would require a surplus return on assets in excess of liabilities of 2.4 percentage points a year for the next three years to recover these losses, she added.