Diversification strategies will change as investors manage risk more than return

June 25, 2012 (NEW YORK) - An annual, independent study released today by CREATE-Research and commissioned by Principal Global Investors identifies investor appetite for a more dynamic approach to managing volatility and asset allocation, with 78 percent of survey respondents agreeing that markets are in an era of prolonged turbulence.

The report, entitled Market Volatility: Friend or Foe, provides a view of the challenges and opportunities presented by market volatility. It surveyed 289 respondents including asset managers, pension plans, pension consultants and fund distributors from 29 countries with a combined AUM of more than US$25 trillion. The survey was followed by 100 interviews.

"The last four years have been the most volatile in the history of equity markets. Price fluctuations of 4 percent or over in intra-day sessions have occurred six times more than they did on average in the previous 40 years," said Prof. Amin Rajan, CEO of CREATE-Research and the report's author. "Extreme spikes in market volatility and closer asset class correlations have been common. History shows that opportunity is inherent in periods of high risk and that high risk can reward active management. Investors want to know whether asset managers can convert market volatility into an investment opportunity."

The headline findings suggest that the asset management industry faces significant challenges in converting the opportunity of persistent volatility into investment performance. Seventy-one percent of asset managers in the study signalled that prolonged market turbulence offers great opportunity for active managers to deliver good returns. Conversely, only 13 percent believe that the industry can currently capitalize on this.  

The report identifies four key actions respondents believe asset managers should take to overcome the challenge and prevent another "lost decade" of returns:

• Develop multi-asset class capabilities (53 percent)
• Ensure interests are more aligned with clients to share pain and gain (53 percent)
• Encourage free-thinking and high-conviction investing (50 percent)
• Promote greater client engagement to minimize risk (66 percent)

"What this report clearly signals is that the asset management industry must take urgent and specific action if it is to capitalize on the inherent opportunity in volatility for clients," said Barb McKenzie, chief operating officer of Principal Global Investors. "It's never been more important to partner with clients and provide customized solutions based on their changing needs and investment goals. At Principal Global Investors, we have relationship managers focused on understanding and delivering against client needs and align our compensation with the results-we don't succeed unless they do."

The report reveals investors, like asset managers, see opportunity in volatility. But their requirements of asset managers have changed. Specifically, in an environment of prolonged uncertainty, they no longer see risk-on/risk-off trades as a binary choice and are becoming more goal-orientated, managing risk more than return.

In practical terms, this means investors-most notably defined contribution and retail-will seek a more dynamic asset allocation strategy, blending elements of both risk on and risk off. The study finds managers believe 49 percent of defined-benefit clients, 45percent of defined-contribution clients and 47 percent of retail clients will de-risk as well as re-risk, using a variety of avenues:

Defined-benefit clients:

• De-risking - liability-driven investing (57 percent), diversification (56 percent) and fiduciary management (44 percent)
• Re-risking - absolute return strategies (45 percent), unconstrained mandates (37 percent), active trading strategies like hedge funds (34 percent) and high-conviction investing (32 percent)

Defined-contribution clients:

• De-risking - advice-embedded products (55 percent), diversification (52 percent) and capital preservation tools (38 percent)
• Re-risking - dynamic glide path strategies (48 percent), absolute return strategies (27 percent) and high-conviction investing (24 percent)

Retail clients:

• De-risking - diversification (48 percent), advice-embedded products (46 percent) and capital preservation tools (36 percent)
• Re-risking - active trading strategies (34 percent) and absolute return strategies (28 percent)

"The effectiveness of diversification has been a topic of debate over the last few years. One of the most compelling insights from the study is that investors' views about risk and return are evolving rapidly, calling for a more dynamic approach to managing volatility," McKenzie said. "A nimble business structure allowing the craft of asset management to thrive along with a focus on risk management and long-term investment are imperative to executing dynamic strategies in turbulent markets, whether it is for capitalizing on volatility or capital preservation."

The full report is available at www.create-research.co.uk and www.create.principalglobal.com.

About Principal Global Investors

Principal Global Investors is a diversified asset management organization and a member of the Principal Financial Group, with expertise in equities, fixed income and real estate investments, as well as specialized overlay and advisory services. Principal Global Investors manages $258.2 billion in assets primarily for retirement plans and other institutional clients. 

About the Principal Financial Group

The Principal Financial Group (The Principal ) is a global investment management leader including retirement services, insurance solutions and asset management. The Principal offers businesses, individuals and institutional clients a wide range of financial products and services, including retirement, asset management and insurance through its diverse family of financial services companies. Founded in 1879 and a member of the FORTUNE 500, the Principal Financial Group has $364.1 billion in assets under management and serves some 17.3 million customers worldwide from offices in Asia, Australia, Europe, Latin America and the United States. Principal Financial Group, Inc. is traded on the New York Stock Exchange under the ticker symbol PFG.www.principal.com.

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