Ahead of the Curve covers developments that may impact the behavior and portfolio positioning of institutional investors. Take a closer look at events in the ever-changing regulatory, legislative and investment markets to determine how they may impact you.
New research concludes coworkers and other peers have a direct influence on the equity exposures of 401(k) plan participants, particularly following periods of strong stock market performance. Previous research has focused on the decision to invest in equity, but this is the first study to look at the role of peers on the level of equity risk in participantsâ€™ portfolios.
Specifically, the study covered the period from January 2005 to December 2009. The data were drawn from almost 174,000 participant accounts randomly selected from more than 600 401(k) plans. On average, close to 70% of the 401(k) assets were invested in equities.
The results indicate that social interactions have a significant impact on participantsâ€™ equity exposure, particularly during periods of stock market volatility. According to the study:
The study also found that peer influence was still significant when the stock market declined, although not as dramatic as during periods of strong performance.
Details of the study and its findings are described in a paper, "Social Interaction Effects and Individual Portfolio Choice: Evidence from 401(k) Pension Plan Investors." The paper is part of a series from The Pension Research Council of the Wharton School of the University of Pennsylvania.
The International Monetary Fund's "Global Financial Stability Report" finds the 2008 financial crisis has made institutional investors more risk-conscious and prompted a greater focus on risk management. Still, investors have not displayed a willingness to assume more risk even in an effort to enhance yield.
Chapter 2 of the report – "Long-Term Investors and Their Asset Allocation: Where Are They Now?" – found that the low-interest rate environment of advanced economies has not yet pushed investors into riskier investments in a search of yield. Still, with interest rates expected to remain low for an extended period, the pressure to do so is expected to grow, particularly for insurers, pension funds and other investors that need to earn a minimum absolute return.
The report also noted the pressure on investors contrasts with regulatory initiatives, such as Solvency II and Basel III, that are aimed at making the institutions safer. According to the report, there is a risk to overall financial stability as these forces could cause institutions to act more like short-term investors and less like the long-term â€śdeep pocketsâ€ť that hold assets throughout market cycles.
During times of market turmoil, investors often seek strategies to help address the turbulence, such as Minimum Variance Portfolios (MVPs). Research conducted by Northern Trust finds, however, the traditional approach to MVP portfolios results in considerable risk, relative to the market, for which investors are not compensated.
The research, outlined in a new green paper, “Minimum Variance Portfolios: Challenging Traditional Concepts of Risk and Return,” shows that while the traditional MVP strategy provides excess market return, it also tends to have high stock and sector concentrations. In addition, the portfolios tend to demonstrate considerable relative-downside risk.
In an effort to overcome these shortcomings, Northern Trust tested a strategy that focuses on high-quality companies with strong dividend yields. This approach delivered excess market return comparable to the traditional strategy with greater diversification and downside protection, while still enabling investors to manage volatility.