Passive investing may mask risks of looming financial crisis: poll

Singapore

A MAJORITY of institutional investors are expecting a global financial crisis to hit in the next one to five years, and most are worried about the market risk posed by passive investments, according to a poll by Natixis Investment Managers.

Two-thirds of institutional investors believe that the popularity of passive investments has increased systemic risk, with a majority highlighting that flows into passive strategies have artificially suppressed volatility. More than half of them are also of the view that passive investing has distorted relative stock prices and risk-return trade-offs.

As large numbers of investors bet on low-fee passive investments over the past 10 years, they have taken advantage of a market that has consistently delivered positive returns, Natixis explains. This suggests that they might not have the full picture, and may be "learning hard lessons in the market downturn as they realise that few of these funds offer risk management", Natixis notes.

According to the survey, respondents have given no indication of making significant changes to their current allocation comprising 70 per cent active investments, and 30 per cent passive over the next three years. Nonetheless, ahead of the expected market volatility in 2019, most expressed a preference for active management.

But even as they anticipate a 180-degree turn from the low-rate, low volatility environment, more than half of those surveyed believe these investors are prepared to handle the risks in the coming year.

Oliver Bilal, head of international sales and marketing at Natixis, said: "Institutional investors seem to have found their optimum allocation between active and passive, and we are now starting to see a slowdown in the growth of allocation to passives.

"Our survey shows this coincides with investor concern over the impact passives could have on market infrastructure and investment returns. We believe that over time, passives will pose huge concentration risk, which could lead to systemic risk and see them truly tested when the next market downturn happens."

"At the same time, appetite for active strategies is a clear indication that in times of market turbulence, institutional investors want a skilled professional at the helm," Mr Bilal added.

Citing interest rates and volatility spikes as key portfolio risks for 2019, 70 per cent of the survey respondents also predict that the next market crisis will likely occur within the next five years.

Notably, institutional investors believe that volatility which roiled global markets in the fourth quarter will continue in the new year, and foresee the end of the longest-running US bull market in history.

Additionally, institutions expect bond markets to be more turbulent, and for equity markets to be volatile as interest rates rise in 2019. In particular, they see the potential for asset bubbles in cryptocurrencies, tech, stocks and real estate.

"More so than market volatility itself, they believe geopolitics, trade wars and the process of unwinding quantitative easing will all have a negative impact on portfolio performance," Natixis said. The Natixis Investment Managers survey polled 500 global institutional investors comprising managers of corporate and public pension funds, insurance funds and sovereign wealth funds. The locations covered include North America, Latin America, the UK, Continental Europe, Asia and the Middle East.