Institutional investors turn attention to alternative indexes – report

Institutional investors could increasingly consider allocation to alternative indexes as the new active decision in beta management, according to new research by the asset management business of Northern on 51 global institutional investors, representing a collective $800bn in assets under management.

Among the institutions Northern Trust surveyed, three in 10 have an existing allocation to alternative indexes and a further 32 percent are considering using them.  Of those using alternative indexes, six in 10 have increased their allocation over the past two years.

“Rather than viewing their investment strategy options as either active or passive, investors today are considering a continuum of options within beta solutions, with traditional market cap-weighted indexes on one end and fully active strategies on the other,” said John Krieg, managing director of asset management, Europe, Middle East and Africa region for Northern Trust.

He added: “As institutional investors face an increasingly challenging environment, they seek increased control and flexibility in their passive mandates and this has largely contributed to the increased interest in alternative indexes.” 

Alternative indices are appealing because they enable investors to access market returns by capturing exposure to specific factors such as value, momentum and volatility. But, deciding to invest in an alternative index, and against which index to invest, needs to be considered in a similar vein to an investor’s active investment allocation decision: 60% of institutional investors we surveyed felt their decision to allocate was like an active decision, requiring a similar level of due diligence.

According to the study, value and low volatility attract the greatest investor focus, with half or more survey participants indicating that their alternative index allocation aims to capture value and low volatility premium.  The survey also shows that the majority of investors with an allocation to alternative indices are looking to reduce their risk through these exposures (92.3%) with diversification coming close behind (84.6%).

Seeking return was less important with just under 54 percent of investors listing that as a driving factor.

Almost half of respondents said that perceived complexity is one of the biggest obstacles in allocating to alternative indexes. As many of these alternative indexes are new, the next biggest hurdle among respondents is lack of a sufficient track record. However, a common theme among most respondents who do make the decision to allocate to alternative indexes is that the strategy helps them meet their expectations.

“Based on responses to the survey, allocations to alternative indexes seem poised to grow as understanding of these benchmarks improves, said Mamadou-Abou Sarr, senior product specialist for global index management at Northern Trust. “While the investment is passive, we believe the decision is active and encompasses four steps.”

In less than 10% of firms surveyed, the index team made the decision to allocate to alternative indexes. Around 70% said the funding for the alternative index portion of their portfolio emanated mainly from assets currently invested in active strategies.

A copy of the white paper and accompanying short video interviews are available to download at – www.northerntrust.com/alternativeindex

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