European institutional investors trends.
Allocations from European institutional investors are on the up. Private credit and ESG are in the limelight, as investors are looking to diversify from equity markets, moving into more thematic approaches focused on urban trends such as smart cities and issues around sustainability and resource scarcity. While Real Estate allocations are cooling off considerably as interest rates increase. Despite macroeconomic issues of volatile markets, massive stimulus leading to inflation, and heightened geopolitics, investors are moving beyond the purely defensive approaches seen at the height of the pandemic and are starting to shape the “new normal”.
With Intelligence’s recent analysis shows that European institutional investors have substantially shifted their outlook. They’re starting 2022 with firm intentions to increase their investment allocations. Alongside this welcome greater appetite for allocations, investors are more interested in opportunities in private credit, and increasingly embracing ESG frameworks. We’ve analyzed 99 profiles of European institutional investors – looking at their intentions, activity, related stories, and applying extra scrutiny to the data, revealing several important findings and themes for the next six months.
Key among these findings is a considerable change in investment intentions from allocators. Between Q3 and Q4 2021 and through January 2022 sentiment shifted significantly – moving from 57% with no intention of increasing their allocations to 56% of investors now looking to make an increase. That’s quite the swing. We put this positive outlook down to investors’ confidence in the vaccine rollout and the widespread effective fightback against Covid variants. Omicron included. The robust performance of many economic sectors helped matters too. This relative economic resilience and positivity continued into January; despite continuing global supply chain imbalances, persistent labor shortages, and expected tightening of monetary policy to tackle inflation.
These recent developments are echoes of the longstanding tendency towards more thematic investing from European institutional investors. A trend that in the past six months has only gathered speed. Themes in focus include urbanization and smart cities, resource scarcity, and most importantly, climate change and ESG. Thematic investing as a strategy is not solely focused on equities, but also covers private credit, real estate, and infrastructure. It’s part of a defensive move as investors seek to offset volatile equity markets and achieve higher yields than bonds are providing.
Proportion of intel stories referencing explicit intentions to invest.
Shifts in institutional investor sentiment are clearly shown in dramatic turnarounds in attitude towards private credit, where inflationary concerns have attracted allocators’ interest.
Between July and November 2021, 75% of institutional investors had no intention of increasing their allocation to private credit – seeing little value in the relatively expensive opportunities on offer. However, January 2022 saw a marked turnaround in confidence, with 57% of investors looking to increase their exposure to private credit.
Direct lending and mezzanine were still the most prominent credit strategies, but they were joined by senior debt as investors sought to reduce risk in their alternative portfolios. This uptick was due to a higher level of deal activity in the latter part of 2021.
And also, thanks to new entrants to the European loan issuance market. The spike was also driven by the current low-yield environment which has hindered investor efforts to generate income from traditional fixed-income assets.
As monetary policy tightens in response to persistent inflation, we think prudent investors will diversify into other credit opportunities – ones offering flexible structures and relative liquidity.
In real estate over the last six months, we’ve seen a move to caution. The sector has been cooling off from the highs of Q3 2021 when 83% of investors wanted to increase their RE allocations. In Q4 and January 2022 this enthusiasm dropped to 56%. The cooling off was primarily driven by the (accurately) anticipated rise in interest rates across the UK and Eurozone, with likely impacts to future returns.
Another factor behind the downward trend? Growing grassroots and party-political opposition to institutional ownership of housing stock. Between July and October 2021, core markets was the most popular RE strategy whilst investors became less conservative between November and January, as they sought greater yield by moving into value-add and RE debt.
Institutional investors along with private equity funds are continuing to invest in core European real estate markets – particularly favoring housing in those major European cities underpinned by the “knowledge” economy. This approach has been encouraged by the historically low interest rates and the chronic undersupply of housing across Europe. Investors forcefully argue that their overall ownership percentage has minimal impact on the overall rental market and rental prices. But, with property ownership at record lows amongst younger demographics, political opposition in Spain and Germany is increasing. The German property market is particularly impacted by this activity given its’ historically large percentage of rental housing stock. As interest rates rise, yield becomes more difficult and the political context increasingly contentious, it will be harder for European institutions to invest in housing.
Nothing happens in a vacuum.
Overview and context .
So, what is the context for these developments? Across developed economies, massive economic stimulus packages have contributed to higher inflation – the eurozone’s annual inflation rate hit 4.9% in November. Throughout 2022, central bankers and policymakers will have to address inflation through tapering bond purchases and interest rate rises. Over the last three months, investors have been telling us they’re increasingly interested in private equity and wealth management. But at the same time, they’re showing noticeably less appetite for the kind of strategies that typically flourish in a low-interest-rate environment. Such as specific private credit and RE strategies like core and direct lending.
The pandemic has caused enormous disruption across all asset classes but conversely, it has also reinforced larger, pre-existing trends. The period of our trend analysis was marked by volatile gas prices caused by geopolitical uncertainty and by a colder than expected winter in Europe. This is reflected in our analysis covering economic topics, where we have seen ESG issues and the macroclimate becoming increasingly important. Both the UK and mainland Europe are now ESG-focused – only 12% of European institutional investors refuse to pursue ESG compliance.
Given the macroeconomic situation and rising interest rates, both the UK and Europe are now more interested in private credit than real estate investments, with the UK trailing slightly in enthusiasm. But in terms of average AUM, the UK is dwarfed by continental investors.
European institutional investors have moved on from being defensive in confronting a pandemic response dominated by regulatory caution and massive economic stimulus leading to inflation. Now, they’re slowly calculating what the “new normal” will involve for markets and their stakeholders.