Long-term investors can just hunker down during market turmoil but they should also not let a good crisis go to waste, according to a new Mercer paper.
The Mercer 2023 outlook for endowments and foundations (E&F) – institutions that often have perpetual mandates – said the sector is “generally designed and invested” for the long-term and should be able to ride out the volatility witnessed over the last 12 months.
But the report notes that “crises often create opportunities for those prepared to capture them”.
“Today, higher inflation, higher interest rates and the growing importance of the energy transition are significant long-term shifts that may warrant a reassessment of asset-allocation strategies with an eye toward opportunities that can be accessed through public and private markets,” the Mercer study says.
E&F investors nursing significant losses following the 2022 multi-asset rout might struggle to muster such optimism but the paper says “it is also important not to be caught off guard: make sure you are positioned to capitalize on compelling opportunities”.
For instance, Mercer says fixed income assets are becoming increasingly attractive while opportunities abound in both public and private markets as well as the broader transition to a sustainable economy.
“E&Fs should reassess their asset allocation to ensure that it remains appropriate in light of higher fixed income yields. It is also worth reviewing the composition of fixed-income portfolios,” the report says.
Similarly, long-term investors able to handle illiquidity risks should seek out exposure to the private markets sector, Mercer says, “at a time when other investors may be retreating”.
And the paper suggests E&Fs may benefit from tilting public market investments to emerging markets (notably, China) or to take advantage of entrenched “longer-term themes such as aging populations in Europe and North America, the digitization of multiple industries, or deglobalization”.
“Currently Mercer recommends an overweight to the value investment style within equities based on fundamentals, valuation and still negative sentiment,” the report says. “Longer term, there may be opportunities within the growth style as the technology and consumer discretionary sectors – key growth sectors – have been hit hard by rising interest rates. Should interest rates decline again, growth stocks may benefit.”
The market downturn should also prompt long-term investors to review environmental, social and governance (ESG) strategies to ensure both financial and “mission” outcomes are aligned.
“Further, we believe this period of turmoil presents a real opportunity for E&Fs to refine their [ESG] approaches and focus on data- and evidence-led investments,” the report says.
During the year ahead E&Fs have four big challenges to manage, Mercer says, covering:
- adapting to higher inflation and interest rates;
- keeping track of ESG investments;
- seizing opportunities in private assets; and,
- capturing long-term trends in public markets.
Overall, the paper suggests E&Fs will need to adopt an active, and nimble, approach to asset allocation as the investment backdrop unfolds.
“The path ahead over the coming months and years is unpredictable, and it is best to explore different scenarios and how they may affect your portfolio, its liquidity, and the ability of your investments to support your organization’s mission and objectives.”