New York (HedgeCo.Net) As the current bullish phase continues, investors seem to be getting more and more skeptical as far as how much longer it will last. As a result, investors are trying to figure out how to participate in the upside as much as possible and at the same time they are trying to protect their portfolios from a drop. This is especially the case for institutional investors.

In an effort to find out how institutional investors are trying to pull of this balancing act, State Street Global Advisors and Longitude Research conducted a survey with 420 executives with the authority to make investment decisions for pension funds—both public and private. The survey was a global one with participants representing Asia Pacific, Europe and the United States. The findings were published by State Street in a white paper entitled Walking the Tightrope.

The findings were both interesting and startling at the same time. The majority of respondents have increased their equity exposure and yet the majority also believes we will see a correction in both developed and emerging markets. In fact, 63% said they have increased their allocations to developed markets over the last six months and 48% have increased their allocation to emerging market equities.

When asked about the likelihood of a correction, 57% responded with “very likely” or “likely” that developed markets will see a drawdown between 10 and 20 percent and the percentages were the same (57%) for emerging markets.
It makes very little sense to be increasing equity allocations while you also feel the market has high probability of dropping between 10 and 20 percent. The survey also asked respondents why they had increased their equity allocations with the following results:

• 64% – Pressure to meet funding requirements
• 58% – Pressure to meet objectives
• 55% – Equity markets continue to offer good value
• 47% – Lack of opportunities to earn a return with other asset classes

What these results suggest is that the low-interest rate environment could possibly be creating a bubble in that institutional investors don’t feel they can earn a decent return anywhere except in equities and yet they have objectives to meet.

As far as risk reduction, 90% of respondents feel their portfolios are structured such that they can weather a major downturn in the market. Ironically, over 40% of these executives haven’t made any recent adjustments to their downside protection, despite an increase in volatility. The survey also revealed that 85% have taken action of some kind to protect the downside and yet 65% believe diversification is enough to protect their portfolio in a correction.

It’s kind of scary to think that 65% of professional investment executives think diversification alone will protect their portfolios. In the last bear market, the average loss for the Select Sector SPDR ETFs was 51.18%. The three defensive sectors (consumer staples, healthcare and utilities) lost an average of 35.7% from October 2007 to the low in March 2009. Remember, these are ETFs that are diversified among ten different sectors and hundreds if not thousands of stocks.
One direct quote from the white paper in particular caught my attention.

While 36% of investors say they are ‘reviewing their need for downside protection’, only 8% say they are currently implementing increased protection. While the majority of these executives think a correction of 10-20% is coming, only 36% are reviewing their need for downside protection and only 8% are actually taking action. That is scary, especially when you consider these are the people referred to as the “smart money”.

Perhaps these people need to be introduced to the HedgeCoVest platform and the models we offer investors. We could help them protect their portfolios from a downturn with something more than just diversification.

Rick Pendergraft
Research Analyst
HedgeCoVest