Exchange-traded funds (ETFs), structured products and index funds are being used increasingly by institutional investors who are buying a wide set of indices or strategies while hedging potential losses, according to a survey by Koris International.
Forty-five percent of respondents to the 2014 European Institutional Risk-Based Investing Survey regard those vehicles as most appropriate when implementing systematic loss control strategies.
ETFs, structured products and investments based on index funds are seen by institutional investors as derivative flexible instruments to hedge very specific risk exposures but also as a way to get synthetic exposure to a given asset class, according to the survey.
Among the investors surveyed, 35% consider exchange-traded derivatives (ETD) as very suitable for rule-based strategies mitigating losses, with 18% looking to OTC derivatives to fulfil the same purpose.
According to the report, derivatives cleared by central counterparties are most fit for institutional investors willing to hedge or synthetically replicate liquid exposures, and mostly include options and futures on interest rates, currencies and equity indices; while OTC derivatives offer investors a wider range of instruments covering almost any asset class, including vanilla and non-standard underlying assets.
In addition, 17% of respondents mentioned active funds as particularly suited for systematic loss control mechanisms. The rationale for investing in such funds, stated the report, is the desire to generate alpha, although they may also constitute a cheaper, more efficient and liquid alternative to Delta-1 products covering asset classes such as high-yield or emerging markets debt.
The report also states that securities are the least preferred for systematic risk-based strategies designed to control losses. Poor participation in the upside was mentioned by 42% of respondents as a major disadvantage of such strategies, while 45% cited bad rebalancing timing as the main drawback weighing on systematic loss control strategies. Readjusting the asset mix when markets are stressed can damage the potential benefits of asset allocation/security selection.
The survey also revealed that 90% of participants define their asset allocation using a risk-based approach, and that a maximum drawdown of 58% and volatility of 56% are the risk measures investors are seeking to control the most.
The survey was undertaken between September 29 and October 15, 2014, with the participation of 74 institutions from 12 countries, including pension schemes, insurance firms, family offices, corporate treasuries, endowments/foundations and other institutions collectively managing €250bn in assets. France, Switzerland and the United Kingdom were the most represented countries.
To read the complete study, click on the link: 2014 European Institutional Risk-Based Investing