Charles Prideaux, head of institutional business for the EMEA region at BlackRock, lists the five things institutional investors should bear in mind for the rest of the year.

Italian election results, the bailout discussions relating to Cyprus and the budget sequestration in the US highlight that, despite tangible progress, much uncertainty remains. Nevertheless, the gradual stabilisation of developed economies is broadly on track and offers institutional investors a fresh impetus to start rebuilding their portfolios.  

Five areas in particular warrant significant attention.

1. Beware the asymmetry in fixed income
As investors are only too aware, policy action and extreme risk aversion have systematically eroded yields, particularly among assets perceived to be 'safe havens'. This decline in yields has supported total returns of government bonds over the last three years, but it also limits the potential for returns in the future. Some investors for whom yield is critical have had to shift towards longer-dated bonds, taking on more duration for an ever-lower yield.

This asymmetry between risk and expected return leaves those 'safe' holdings vulnerable to any trend reversal in yields. The exact timing and extent of such a reversal is hard to call, but we have now entered a risky period in which policymakers and markets are liable to shift their perspective. Conversely, it may also generate opportunities for investors with liabilities that are currently unhedged. Longer-term, fixed income investors also need to prepare for an environment that may differ substantially from the 30-year period of falling rates that is now coming to an end.

2. Demand more from your beta strategies
An essential step in the process of regenerating portfolios in today's challenging world involves extracting maximum efficiency per unit of risk taken. The growing segment of passively managed assets offers a particularly fertile hunting ground from this perspective. Although progress has been made, significant opportunities remain for enhancing the risk-adjusted return trade-off within beta portfolios. Achieving this entails having a deeper understanding of the embedded risks and a stronger awareness of the implications of benchmark choices. This, in turn, translates into a more systematic use of alternative forms of beta to achieve desired risk exposure and return objectives – whether to reduce volatility or enhance return potential at lower cost.

3. Strengthen allocations to emerging markets
Many investors remain reluctant to build allocations to emerging markets that are commensurate to the opportunity set, perhaps mindful of the crises of the past. However, the reality is that much has changed over the last 20 years: emerging economies are now in a much stronger position than many of their developed counterparts, while still benefiting from superior GDP growth. It is therefore important to adapt a dynamic risk framework that reflects current volatility patterns rather than historical averages. Investors should also take into account new opportunities, such as local currency EM debt, for enhancing the overall risk/return trade-off. Passive exposure may be the default stepping-stone, but there is growing scope for capturing alpha and mitigating risk through active stock selection.

4. Re-engineer alternatives allocations
There is a growing recognition among investors of the need to re-adjust their perspective on alternatives if they are to achieve the necessary diversification and improved risk-return potential. In effect, this requires a wholesale 're-underwriting' of alternatives allocations in line with overall risk and liquidity budget constraints. An increasing number of investors are also looking for alternatives to become an integral part of their mainstream portfolio, while simultaneously casting the net wider to take advantage of uncorrelated opportunities that were hitherto unavailable, such as infrastructure. Successful implementation starts with bottom-up risk management – digging deeper into the individual strategies and asset classes to understand their underlying risk/return drivers and to seek out true differentiation and opportunity. It also means measuring and managing the associated risks on a more dynamic basis.

5. Achieving desired outcomes through multi-asset approaches
Over the years, institutional investors have made great strides in aligning their investment strategies more closely with the outcomes they seek. However, despite improving markets, institutional investors still face an uphill battle against rising longevity and greater regulatory pressures. Therefore, in addition to optimising the individual building blocks, investors should focus on how their portfolios behave in aggregate and ensure their risk budget is aligned with the risk factors that matter.

In volatile and uncertain markets, where even 'safe' fixed income assets are subject to potential shocks, asset allocation plays an even more important role in driving returns. Asset allocation approaches that allow investors to capture returns across a range of asset classes, while mitigating exposure to unrewarded risks, are therefore optimal. These can take several forms, but they usually involve a greater use of medium and tactical asset allocation views, combined with rigorous risk management.

Charles Prideaux is head of institutional business for the EMEA region at BlackRock