Despite dreadful performance in 2022, when the prices of stocks and bonds both fell, institutional investors did not make significant changes to their investment portfolios. However, elevated inflation, higher interest rates, and more volatility should have them wondering if allocations of old will work going forward, Fidelity Investments says.
Pension funds, endowments, foundations, insurance companies, and other institutions reported an average actual rate of return of 12.3 percent in 2020 and 12.7 percent in 2021 — well above their long-term target of 7.5 percent, according to a survey of 500 institutions by Fidelity. Since then, there has been less to celebrate. Institutions returned 1.1 percent in 2022 and the new market regime in 2023 has made the economic future opaque.
Despite lower returns and uncertainty, most institutions are unfazed and making few changes to asset allocations. When Fidelity asked investors if they were confident they would achieve their target return in the next three years, 54 percent said they were in 2022 and 51 percent said the same this year.
Even the worst performing groups of institutions had the same level of confidence about their target returns over the next three years, Fidelity found. In 2022, insurance companies posted the best returns at 2.7 percent, while pensions, endowments and foundations returned under 1 percent.
“There seems to be an underlying sort of confidence...that institutions will hit their bogey of about seven, seven-and-a-half percent for the next three years going forward. I found that one to be a bit of a surprise just given the pronounced volatility,” Chris Pariseault, head of institutional portfolio managers at Fidelity, told Institutional Investor.
Confidence might be up in 2023 because a portfolio of 60 percent stocks and 40 percent bonds is up 13.2 percent, according to Pariseault. “The other thing I would say is while most investors do see a fair amount of volatility going forward, there was an acknowledgment that it’s not so easy to change the strategic asset allocation. And so not to say that there’s complete inflexibility, but there was an acknowledgment that it’s not so easy to do,” Pariseault said.
Sixty percent of the institutions surveyed by Fidelity said they “struggle to move an idea through to action quickly enough” when it came to their strategic asset allocation.
They should still consider changes and try to implement them though.
“We believe 2022 was not as much an anomaly but a harbinger of a new regime where volatility is manifesting in a different way than in the past — and institutions should adjust their thinking to ensure they are prepared for what lies ahead,” Fidelity said in its report.
Many institutions acknowledged that they are prepared for the macroeconomic risks that most forecasters are expecting in the near future. Roughly half of all institutions said inflation, geopolitical concerns, high valuations, and a low-growth environment were the biggest risks but they were not equally prepared for those things. About half said they were prepared for inflation but just 28 percent were well positioned for geopolitical risk, 30 percent for high valuations, and 40 percent for slower growth.
Smaller, tactical shifts to portfolios can make a meaningful difference but getting the overall portfolio allocations right is what matters most. Fidelity’s research has found that strategic asset allocation design accounts for 85 to 90 percent of investment outcomes.
“Getting that big strategic allocation right is really important,” Pariseault said. “It really does feel as though we’ve reached this turning point in terms of monetary fiscal support.”
