Corner Office Views | Q3 2022
Institutional Asset Managers in Europe Shift Allocations to Mitigate Market Volatility
Rethinking strategic allocations
- A Cerulli survey finds that asset managers are looking to improve their environmental, social, and governance (ESG) reporting and measurement capabilities, increase the number of strategic partnerships they have, and grow their insurance asset management business.
- The asset managers Cerulli surveyed anticipate increased flows throughout Europe over the next 12 to 24 months, expecting to see the most significant flows in the German and U.K. markets.
- Asset managers told Cerulli of the potential opportunities arising from an accelerated push toward boosting energy infrastructure and suggested there is an argument that infrastructure (private or public) should have a more favorable capital charge.
Over the past few years, asset owners’ funds have embraced alternatives such as private equity, infrastructure, and private debt as part of their hunt for higher yields. The diversification and promise of higher returns would normally be good protection against inflation and ensure growth. Now, however, market volatility and higher bond yields are causing some managers to rethink their strategic allocations.
At the beginning of 2022, asset managers generally expected inflation to level off in the second part of the year. However, that expectation did not materialize, with higher levels of inflation expected for a longer period. In response, central banks have made significant increases to interest rates, marking the end to the era of low yields.
Managers believe rising rates may draw interest away from private debt and equity for as long as the rise in yields, a global trend, continues. However, the current volatility has extended to the European bond market, with asset managers being caught between a central bank raising rates and the prospect of a recession.
For the first time in more than a decade, listed stocks and bonds are positively correlated. Combined with geopolitical tensions, high inflation, and monetary policy shifts, this means investors are having to look further afield to achieve returns.
So how do managers intend to grow their business in the face of market volatility?
Major drivers of growth
The asset managers Cerulli surveyed for our most recent report anticipate increased flows throughout Europe over the next 12 to 24 months, expecting to see the most significant flows in the German and U.K. markets.
The same survey found that asset managers are looking to improve their environmental, social, and governance (ESG) reporting and measurement capabilities, increase the number of strategic partnerships they have, and grow their insurance asset management business. Institutional investors are increasing their already-significant demand for accurate reporting on ESG factors, looking for more detail on green bonds, ESG ratings, carbon emissions, and so on. One asset manager told Cerulli that asset owners are looking at the proportion of green bonds in a bond portfolio and some are setting targets to increase this proportion. Our survey of insurers found that 46% of respondents are already invested in green bonds and that 49% are either likely or very likely to invest in them in the next 12 months. Italian insurers feel the strongest about increasing their exposure to green bonds, with 35% very likely to incorporate such products into their fixed-income strategies in the next 12 months.
The pursuit of strategic partnerships is growing throughout the European asset management industry. The level of cooperation within these partnerships varies widely in terms of the level of service provided and the proportion of assets managed on behalf of the client. One asset manager Cerulli spoke with described their strategic partnerships as hugely important in an increasingly competitive market. Strategic partnerships help asset managers extend and deepen their relationships with clients, but also open the possibility of fee discounts. One of the benefits of having multiple partnerships is that they allow managers to demonstrate their ability to work with different types of insurers. Asset managers can use strategic partnerships to show that they can manage complex insurance mandates.
That being said, strategic relationships can require substantial resources—and fee discounts. One asset manager told Cerulli that, although it can successfully cross-sell to strategic partners, the thin margins on fixed-income products cancel out any profitability from the cross-selling activities. As a consequence, many managers value strategic partnerships for reasons other than profit generation.
Some strategic partnerships can be more profitable than others based on the nature of the arrangement. Asset managers told Cerulli that strategic partnerships with larger insurers that focus on alternatives and private markets are profitable, whereas whole-balance-sheet partnerships with smaller tier-3 insurers are less likely to return a profit. As discussed previously, strategic partnerships have benefits beyond just profitability—they can be useful in demonstrating client service and value add—and asset managers should be mindful of what they want from their partnerships.
ESG reporting and measurement capabilities as a differentiator
ESG is a key area and asset managers will find opportunities to work with insurers on building their responsible investment policies. As European institutional investors become more vocal in demanding action on climate change risks, asset managers will need to pre-empt their demands. Managers should proactively aim to improve their reporting and measurement instead of waiting for their clients to request information on ESG issues. In addition, asset managers should take all necessary steps to develop a strategy to address climate change in line with the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD); this is set to be a standard requirement for large European institutional investors.
That being said, asset managers are finding that their current partnerships with clients, especially insurers, are increasingly challenging to fulfil because of the increased resources they have to allocate to ESG reporting. Managers have to justify the increased resources they devote to partnerships in these areas. However, such assistance is important in that is demonstrates client service and value add.
Private investment programs
Insurers and pension funds are still looking at private investments, given that interest rates are not guaranteed to continually increase as fears of recession grow. Private markets may still be the right avenue to generate yield in the medium and long term. One of the root causes of European inflation, the need for Europe to be weaned off Russian gas, may expedite some opportunities in private investment and could push ESG projects along. Asset managers told Cerulli of the potential opportunities arising from an accelerated push toward boosting energy infrastructure and suggested there is an argument that infrastructure (private or public) should have a more favorable capital charge.
For some asset owners, inflationary pressures have further increased the need for private investments to generate higher yields and outperform in the medium to long term. In addition, increased market volatility, regulatory requirements, and growing ESG reporting standards may create opportunities for asset managers. Those that can demonstrate their expertise in alternative asset classes will be well placed to win business from European insurers seeking external investment know-how.
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