Despite a partial recovery in markets in 2023 after a horrendous 2022, asset owners are most worried about persistent high interest rates and inflation and how these issues will affect their portfolios, according to investment consulting firms.
Indeed, after plunging 18.1% in calendar 2022, the broad S&P 500 index climbed 16.9% year-to-date through June 30.
Meanwhile, the annualized inflation rate has dropped from a recent peak of 9.1% in June 2022 to 3.2% in October 2023 — but that figure remains well above the Federal Reserve’s 2% target. The Fed’s key benchmark rate has been frozen in a range of between 5.25% and 5.5% since July, but that followed an unprecedented flurry of 11 rate hikes since March 2022.
Institutional assets under advisement at consultants jumped to $47.9 trillion as of June 30, up 2.3% from a year earlier, according to Pensions & Investments data. Over the past five years, that figure has surged by 26.4%.
Bryan Ward, senior partner and head of solutions and sales at Aon Investments USA, which had $4.36 trillion in worldwide institutional assets under advisement as of June 30, said high interest rates remain the top-of-mind concern of his asset owner clients. “Not only how high rates are now, but how long they will remain at these elevated levels given that inflation has remained stubbornly high,” he said.
The high interest rate environment has made both fixed-income investments and cash more attractive on a relative basis than was the case in prior periods, Ward said. “Because of this, we are advising clients to review their fixed-income strategy for additional opportunities, both from a return perspective and current yield,” he said. “Second, we’re stressing caution on equities, particularly public. The higher interest rate environment is a potential headwind to earnings due to higher financing costs. Further, should the economy enter a recession, there will be additional pressure on earnings, resulting in potential equity market weakness.”
Aon is also advising clients to look at allocating to “liquid, uncorrelated alternatives such as low-beta hedge funds,” he said. “Our team is also finding opportunities in private credit and real assets. These strategies build resilience into portfolios and provide diversification benefits relative to long-only equity portfolios.”
Jeffrey MacLean, CEO of Verus, said that his asset owner clients are most concerned about what the higher interest rate regime means for their portfolios. “There are the lingering (negative) effects of the high-rate regime on their real estate portfolios and private equity activities,” he said. “We have moved from a zero-rate environment to a rising-rate regime, which has the potential to cause disruptions in markets.” Verus had $759 billion in worldwide institutional assets under advisement as of June 30, up 12.1% from a year earlier.
Greg DeForrest, executive vice president and head of fund sponsor consulting at Callan, said his institutional clients are also concerned about staffing levels and governance structures for their respective organizations, “including reporting lines and whether discretionary or non-discretionary advisers should be utilized.” They’re also concerned about spending active risk appropriately, he added, “and looking at the right combination of liquid and illiquid assets in their portfolios.”
Callan had $4.71 trillion in worldwide institutional AUA as of June 30, down 1.5%.
Aside from rising interest rates, noted Frank Benham, director of research at Meketa Investment Group, his firm’s clients are also concerned about the potential for an economic hard landing, as well as both political and economic risks in China.
Regarding China, Amy Hsiang, managing principal and director of public markets manager research at Meketa, said clients are interested in learning more about emerging markets.
“Whether or not that translates to actually increasing allocations to emerging markets, only time will tell,” Hsiang said. “We have not seen clients actively avoid China.”
Meketa had $2.81 trillion in worldwide institutional assets under advisement as of June 30, relatively flat from the year before.
However, China, the second-largest economy in the world, is beset by an array of problems, including a slowing economic growth, rising youth unemployment and a real estate market in crisis. MacLean of Verus said some clients are also worried about rising diplomatic tensions between Beijing and the West, which has already disrupted supply chains and resulted in shortages in Western nations.