By Joel Kranc

A post-COVID economic environment has had no breaks in volatility and events for institutional investors in 2023. Geopolitical flare-ups, inflation, the start of the political season in the US, and a host of other issues have affected and changed the way institutional investors have had to think about their investments.

A report from Schroders, the Institutional Investor Study 2023 Global Report, says that of 770 global institutional investors surveyed, 55% expect geopolitical uncertainty to have the greatest impact on portfolio performance, while 53% say inflation is doing that. The survey notes that 48% believe tapering monetary policy are high on the list of issues as is stagflation with 42% saying it will impact portfolio performance in the short-term.

“Markets continue to be caught in the cross currents of concerns about rate increases and worries about recessionary risks,” notes Johanna Kyrklund, Group CIO and co-head of investment with Schroders.

“The study found that institutional investors’ allocations to equities may look to increase as they intend to capitalize on the opportunities presented by the de-globalization, de-carbonization and demographic trends. With concerns about high inflation and high interest rates, valuations matter. A renewed focus on valuations rather than speculative growth may be required,” she adds.

“There was, coming into 2023 and now coming out of 2023, a heightened sense of macro-risk, which are volatility drivers, because whether its inflation or a world view, those things are influencing the risk-return profile,” notes Todd Glickson, head of investment management with Coalition Greenwich.

He notes that as institutional investors look at volatility and inflation risk, it will feed into their asset allocation, not just where they are now but where they are going. “I think one of the things you’ll have to look at, particularly if you are one of the large pension plans in Canada, given where we were with lower interest rates and then going up, and how that affects balance sheets, is that pension funds are really well funded. What that tells you is that you need to think differently about the risk-return profile. If you are comfortably fully funded, you are more focused on maintaining that surplus than you are on adding alpha, which means you think differently about asset allocation approach and managers you are working with.”

That, he adds, has moved these institutions into more private investing, which is less volatile. And within the Canadian market institutional investors are embracing alternatives, particularly in the areas of private debt and private infrastructure. “You saw it in 2023, and we expect to see it going into 2024.”

Canada is also similar to Europe in terms of adoption of ESG and investment principles, he says. Managers have “fully baked” the ESG processes into their strategies. “The bar has been higher than it has been before on showing investments are as good, if not better, than investments on the risk-return side but I think more asset managers (and institutional investors) have been successful in doing that.”

Alexandre Roy, senior managing director, Total Fund Management with PSP Investments, says 2023 was a challenging and difficult market. “Despite the fact that the market was very volatile and difficult, I think that PSP has been successful in delivering good returns. A key reason is the resilience of the portfolio.”

He points to PSP’s ability to deal with inflation and looking at asset classes such as infrastructure and natural resources. “These asset classes were top of mind for us, not just because we think it provides a good return, but also because of the inflation pass-through that these asset classes provide,” he notes. “The fact that we have regulated assets, or assets that are sensitive to inflation, is key to us.”

Investments in credit investment as an asset class has been sensitive to interest and has helped the portfolio, as well, notes Roy. “If we build a portfolio that is resilient to different types of environments, I think this is where we can extract the most out of this difficult environment.”

And while Glickson says there has been more dry powder waiting for deals, there has been a great diversity of transactions that was absent in past deals. “Asset classes are emerging, that weren’t in full bloom, like infrastructure,” he adds. “Canada has always embraced real assets, and the Canadian market has been a leader in infrastructure because it has similar risk-return profile to real estate, and has high total returns, high income stream and monopoly-like characteristics.”

Another interesting feature that PSP has used in this past year was with currency. “Currency is not an add-on,” explains Roy. “It is part of the process and equivalent to another asset class … it costs nothing to deliver the diversification that comes from currency.”

Similarly, PSP’s ESG strategy, which started in 2022, has been considered as an integral part of the investment process and not an add-on. “We believe at PSP that climate change is something we need to consider when we build an investment strategy and an investment thesis.”

In fact, the Schroder’s survey says that 67% of investors agree that the energy transition will spur investment in innovation thereby creating significant investment opportunities. Similarly, 46% of global investors believe that infrastructure/renewables are best placed to capture energy transition investment opportunities in the medium-term.

As 2023 ends and 2024 begins, institutional investors will still be assessing some of these issues, as well as unforeseen areas, even as inflation comes down and economic reports show strong growth.