Among the major minefields that investors must navigate in 2018 will be expanding asset bubbles and greater volatility, according to 500 institutional money managers worldwide surveyed by Natixis Investment Managers, in a report released today. Survey respondents have a lot of market clout to say the least: collectively more than $19 trillion of assets under management (AUM).  As a group, they expect sectors such as technology and health care to outperform next year as utilities and real estate lag.

Biggest Threats to the Markets

Most striking, more than three quarters of these mangers - 77 percent to be exact - are concerned that the extended period of low interest rates has created asset bubbles, while 59 percent believe that low volatility should be another cause for worry. So it's no wonder these investors, as a group, appear quite cautious: as mentioned below, their average asset allocation in stocks is only 37%. Headquartered in Paris and Boston, Natixis had $961 billion in global assets under management as of September 30, per this report.

Geopolitical events, especially tension with North Korea and instability in the European Union (EU), are mentioned as major threats to the markets by 74% of respondents. Other threats with high levels of mention are: asset bubbles, rising interest rates, low yields, and the unwinding of quantitative easing by central banks

Skeptical About Passive Investing

Additionally, the majority of respondents believes that the rapid growth of passive investing has created a number of problems, including: an artificial reduction of trading volatility (59%), a distortion of relative stock prices and risk-return tradeoffs (56%), as well as an increase of systemic market risks (63%).

Worse yet, 72% of respondents believe that individual investors are unaware of these risks and distortions.

Concerned About Bubbles

In a period of extraordinarily low interest rates, investors have been desperately reaching for yield, crowding into ever riskier assets, and thus creating asset valuation bubbles in the eyes of many survey respondents. Indeed, 71% of respondents believe that institutional and individual investors alike have been assuming excessive risk in the search for yield. As far as bubbles in particular asset classes go, 30% of respondents see one in stocks, 42% in bonds, and 64% in bitcoin.

Expecting Greater Volatility

Of the institutional investors polled by Natixis, 72% are surprised that volatility in the markets has been so low for so long, and most anticipate that 2018 will see an increase. Greater stock market volatility is expected by 78%, and more bond market volatility by 70%. Meanwhile, 76% find that alpha, or security-specific returns uncorrelated with general market movements, has become more difficult to find as the markets have become more efficient.

Nonetheless, 36% indicate that they do not hedge their portfolios, sometimes the result of regulatory or mandate limitations. Among those who do, 18% plan to increase their use of hedge fund strategies in 2018.

Sector Picks For 2018

The top sector picks to outperform the market for 2018 are, per the survey: technology (45% of respondents), health care (44%), defense & aerospace (43%), and financials (41%). The sectors deemed most likely to underperform are utilities (41%) and real estate (31%).

The average asset allocation among respondents currently is: 37% stocks, 34% bonds, 21% alternative investments, and 5% cash. More than 90% have their equity holdings diversified across developed and developing markets. For 2018, 46% expect the Asia-Pacific region to offer the best emerging markets investment opportunities.

Allocation Changes For 2018

These are the broadly-defined investment allocation changes that respondents plan to make in 2018, with the percentages of respondents indicating these intents:

  • Less U.S stocks (36%)
  • More European equities (33%)
  • More emerging markets stocks (27%)
  • Less high yield debt (33%)
  • Less government debt (26%)
  • More emerging market bonds (24%)
  • More private equity (39%)
  • More private debt (36%)
  • More real estate (33%)
  • More infrastructure (33%)

Interestingly, real estate is cited by the survey as both a likely underperformer in 2018, and as a target area for increased investment. This suggests a division of opinion among respondents. Private equity and private debt are cited by majorities of respondents (61% and 58%) as providing better diversification than their publicly-traded counterparts. However, 44% say that the lack of transparency in private equity discourages them from investing in it.