Market ups and downs weigh on balance sheets

Added 7th January 2016

Market volatility has emerged as the key risk for institutional investors, said Fabrice Chemouny, executive VP and global head of institutional sales at Natixis GAM.

Market ups and downs weigh on balance sheets

Market volatility is seen by some analysts as the new normal, given factors such as the economic slowdown China, falling oil prices and uncertainty surrounding central bank moves on interest rates.

The spikes and slides in commodity and currency prices have a direct impact on the balance sheets of institutional clients, especially for those who adopt the mark-to-market accounting practice, Chemouny said.

Institutions, such as pension funds, tend to use mark-to-market accounting -- assessing asset prices as they are, not what they could be -- to help ensure pension payments are met.

However, prices get distorted during market volatility and to avoid a balance sheet loss, an institution may be forced to sell an asset that is temporarily down.

“Volatility becomes a problem as mark-to-market accounting can impact the balance sheet of firms as market conditions change.”

"In the EM debt space, we see more traction for short duration debt as opposed to long duration debt."

Alts appeal

Volatility has made alternative asset classes more attractive as a way to lessen overall portfolio risk, Chemouny believes. Alternatives generally rely less on broad market trends and more on the strength of each specific instrument, thereby providing some cushion against macroeconomic shocks.

Chemouny noted that in recent years, emerging market debt is becoming a compelling alternative source of yield and diversification.

“In the EM debt space, we see more traction for short-duration debt as opposed to long-duration debt. We have seen our clients diversifying into this asset class and we expect demand [for short duration EM debt] to increase this year.”

Chemouny pointed to the Natixis LS Short Term Emerging Markets Bond Fund as an example. He noted that the fund’s assets under management was $35mn in 2013. In 2014 and 2015, the fund’s AUM increased to $48mn and $111mn, respectively.

Asian demand for alternatives is coming from Hong Kong, Japan, South Korea, Singapore and increasingly, China, he said.

“These countries have been active over the last few years on EM debt.” However, a change in trend is the duration, he added.

Institutional investors also have concerns about evolving regulations, he added. For example, the Dodd-Frank Wall Street Reform and Consumer Protection Act calls for new corporate compliance structures, increased reporting from public companies and stress tests for large banks and non-bank institutions. Although enacted over four years ago, areas of the legislation are still being debated and supplemented.

“Regulatory changes such as the Dodd-Frank Wall Street Reform and Consumer Protection Act has dramatically changed the environment for insurance companies,” Chemouny said.

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