When it comes to institutional investing in the current climate, what is considered optimal or adequate in terms of diversification, and what should institutional investors prioritize in their portfolio to ensure long-term growth?

Today's subject matter expert

Gary Chin
Jean de Kock
Strategic Research Director, Asia & IMEA, Mercer

There are a multitude of challenges for the institutional investor to grapple with in today’s environment: inflation, demographic shifts, monetary tightening, resource conflict, below trend growth, banking sector stability, geopolitical tensions and climate change, to name a few. These forces and the interaction between them are sure to contribute to periods of short-term volatility across investment markets and indeed may impair longer-term value creation. Given that no outcome can be predicted with any certainty, Mercer ’s advice favors a longer investment horizon to mitigate short-term risks and to benefit from long-term trends.


Dynamic diversification


Over a longer time  time horizon, institutional investors are advised to diversify their portfolios to reduce the impact of any unfavorable outcome within one specific asset class or country of risk, and therebyfore enhance risk-adjusted returns. Portfolios should comprise as broad a range of asset classes, industries and geographies as possible. In today’s environment, many investors will no doubt be giving thought to how they approach diversification within the context of portfolio construction. Because relationships between asset classes may not be as predictable and stable as investors have been accustomed to, they should look at ways of diversifying more dynamically to both ensure sufficient diversification within their portfolios and as well as access to the necessary sources of alpha.; tThis can be achieved at the committee level given sufficient governance resource, or by utilizing mandates with discretion to be dynamic.


Alternative assets


A key risk to consider is that tThe inflationary regime may persist for some time. In such an environment, equities and bonds are likely to be positively correlated, and therefore bonds may therefore provide scant protection. and tThis could be a reason driver to consider real assets and alpha sources, amongst other levers.


Investors today arguably have more tools than ever before, with hedge funds and private allocations providing investors with the ability to create sophisticated and well-diversified programs in both arenas. A long-term horizon should mean that institutional investors are able to benefit from illiquidity premia; any allocation to alternative or private assets should be carefully balanced with traditional assets that can be quickly liquidated to take advantage of opportunities as they arise.


A further consideration could be explicit downside protection strategies, which will require patience to be effective. Like insurance policies, these strategies come with a recurring cost but should act as a complement to a growth portfolio of hedge funds, for example.

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