Other themes we see include:

• Incremental risking-up of portfolios to reach for return
• Concerns over volatility from risked-up portfolios
• Pursuit of further portfolio diversification
• Refinement and reconsideration of corporate de-risking strategies
• Questioning non-U.S. equity allocations following several years of sharp underperformance relative to U.S. equity
• Revisiting hedge funds and the implementation of absolute return allocations
• Pursuit of real return strategies while inflation remains benign

Other observations:

• Active/passive: The argument to retain active to protect in a down market and be nimble in a volatile, low-return environment is compelling, but plan sponsors are weary of historical underperformance in equity.
• Fixed income: Callan believes structure discussions in fixed income should focus on the role of fixed income as the anchor to windward and a flight to quality hedge, given the substantially reduced size of the fixed income mandate for many funds. Anything with the potential for higher yield looks appealing – credit, opportunistic, an array of private debt strategies – even as spreads grow ever narrower. Fund sponsors are considering re-casting fixed income exposures to include Treasuries and cash to serve three goals: liquidity, flight to quality, and low correlation to equity. Underfunded plans are also focusing on fixed income as an explicit source of liquidity.
• TDF glidepaths: Sponsors of target date glidepaths are revisiting exposures to overall risk assets, particularly for equity allocations. Conservative glidepaths have lagged in the U.S. equity bull market, applying pressure to risk up the paths. Those with a global equity footprint are under similar pressure (due to the lackluster performance of non-U.S. equity). Innovation has been stifled by factors including litigation and heightened fee sensitivity.
• Hedge funds: Disappointment with hedge funds is leading plans to pursue replacement with multi-asset class (MAC) and other liquid strategies in the absolute return sleeve. The size of the assets in play and the sophistication of the strategies under consideration are noteworthy. Capacity constraints within some MAC strategies are already apparent.

Diversification appears to have come at a high cost over the past five years. U.S. equity has enjoyed a phenomenal run, outpacing most other asset classes, especially the diversifiers. Even worse, U.S. equity has been the primary source for funding these diversifiers. While this result is what one should expect – diversifiers should not perform in line with equity – the disappointment has led many fund sponsors to at least question their diversification. Non-U.S. equity and hedge funds are the most common source of complaints. Callan will explore this topic at our June client workshops, titled “Why Diversify?”