Executive summary:
- Institutional investors may want to consider increasing their allocation to U.S. small caps and leaning further into private markets.
- Large institutional investors that don’t already use an OCIO provider should consider having a transition management partner in place.
- Non-profits should ensure that their investment strategy is in alignment with the goals of the enterprise.
- DB plan sponsors may want to consider increasing their contribution rates if financially feasible.
- DC plan sponsors should consider adopting a multi-manager structure.
While every new year arrives with its own unique set of opportunities and challenges for institutional investors, we believe 2025 could offer more than the typical share. Why? For starters, big changes are already afoot as the year opens, with the new administration of President Donald Trump already pursuing sweeping adjustments in areas like trade, immigration, fiscal policy, and deregulation. Changes in these areas may result in notable impacts to investor portfolios, as illustrated in our 2025 Global Market Outlook. In addition, we expect that the ongoing shift toward private markets will continue to present institutional investors with increased access to compelling investment opportunities.
Meanwhile, further clarity around the Federal Reserve’s (Fed) monetary easing stance has the potential to make the year another strong one for portfolio transitions. By a similar token, the recent robust performance in U.S. equity markets could make 2025 an appropriate time for defined benefit (DB) plan sponsors to consider increasing their contribution rates if financially feasible. Last but not least, the current environment also presents new opportunities for defined contribution (DC) plan sponsors and non-profits—including endowments, foundations, and healthcare systems—to consider.
This article, categorized by market segment, shares some of the key issues we think institutional investors should consider as 2025 gets underway.
1. All institutional investors: Consider increasing your allocation to U.S. small caps and integrating private markets into your portfolio.
We think U.S. small caps could play an increasingly important role in investor portfolios as the year gets underway. This is largely due to the expected pro economic and business growth policies we plan to see unveiled from the new administration. U.S. small cap names stand to be a beneficiary if these types of policies come to fruition, particularly companies in high-growth areas like finance and software. In addition, the attractive valuations of U.S. small cap stocks in comparison to their large cap counterparts, coupled with an improving earnings outlook for 2025, suggests ample opportunities in this space.
We also believe the environment this year may prove to be more favorable for private markets investors, due to a combination of expected looser regulations, stabilizing interest rates, and a potential rise in mergers and acquisitions. In addition, the ongoing shift away from public markets continues to accelerate. Case-in-point: Venture capital investments now make up 27% of deals and 41% of capital raised. From our vantage point, investors who capitalize on this trend by leaning further into private markets may be well-served in 2025. However, we’d stress that a multi-manager approach is, in our opinion, a crucial component to achieving success in this new landscape. By diversifying across specialized managers, particularly in real assets, we believe investors can access a broader range of opportunities that blend both public and private market investments.
2. All large institutional investors: Consider having a transition management partner in place
As we recently noted, our customized portfolio solutions (CPS) team has seen a marked uptick in portfolio transition events over the past six months. While every institutional investor has their own specific reasons for transitioning assets, we believe some of this increase was due to investors wanting to make changes ahead of the recent U.S. elections due to potential volatility concerns, and some due to the additional clarity from the Fed on the path forward for rates. Notably, we expect this trend to continue in 2025 even with political uncertainty and wavering Fed policy.
When looking to move assets, we believe most investors that don’t already use an OCIO provider are best served by partnering with a qualified and experienced transition manager rather than attempting to handle the transition on their own. Why? Put simply, the process of transitioning assets is often highly complex and risky. Factors such as country domiciles, the regulatory environment, currency considerations, and the liquidity associated with the old and new managers must all be considered. For an organization without the right capabilities, the process can lead to inefficiencies, unnecessary trading, tax drag, and loss of market exposure.
Because the need for a portfolio transition can materialize quickly, we believe it’s crucial for institutional investors to have a transition manager lined up well in advance of any potential transitions. However, finding the right transition manager to work with—one with a blend of deep expertise and specialist skills—takes time and research. Yet we all know markets don’t work on a similar timescale. Recent years have demonstrated all too well how they can quickly turn on a dime, making the need to have a transition manager in place before moving money all the more vital in order to avoid unnecessary exposures and risks.
The key takeaway here? Consider conducting your due diligence on transition managers and securing a partner (or multiple partners) soon, before any potentially rough seas surface. Otherwise, it might be too late, and the results could be costly.
3. Non-profits, including endowments & foundations and healthcare systems: Make sure your investment objectives are aligned with the goals of the organization.
The post-pandemic environment of high inflation and high interest rates has been a double whammy for many non-profits, which have seen their costs rise while the cost to finance debt has become more and more expensive.
When setting the investment strategy to align with enterprise needs, we believe non-profits should consider their risk tolerance and return objectives.
For healthcare systems, ensuring alignment with the enterprise needs will likely depend on operations and financing conditions. Organizations with strong operations and financing capacity typically will be able to take on a higher level of risk. Conversely, those with stressed operational and financing capacity will usually have a lower tolerance for risk, even if they have the stronger desire for income from the investment portfolio.
Endowments and foundations, meanwhile, should carefully consider how any changes in strategy could impact their ability and need to support the communities they serve, and if they’re more likely to be affected by rising costs and inflation or economic stress. These considerations should influence how their portfolios are positioned to withstand different potential economic shocks.
Ultimately, there is no one-sized-fits-all answer given the unique needs of every non-profit. However, we believe that a holistic framework that incorporates the needs and concerns of the enterprise is an essential starting point for all organizations. Consider developing or refining yours this year.
4. DB plan sponsors: Review your plan’s funded status in the context of the corporate balance sheet and right-size the contribution policy
Our recently released annual Prudent Pension Funding Report demonstrated that although most defined-benefit plans are still on track to achieving full funding by contributing a small percentage of their cashflow from operations, slight changes in interest rates or a company’s financial situation can have outsized impacts on their funding goals and the burden the pension plan presents.
Consider, for instance, that in 2022, 5% of companies in the Russell 1000 Index were contributing anywhere from 2% to 3% of their corporate cashflow to their pension plans on an annual basis. At the time, this would have resulted in their plans achieving fully funded status in eight to 13 years—an attainable timeline. One year later, however, the timeline for full funding for this subset of companies ballooned to over 100 years—turning what was once a solvable problem into a perpetual, seemingly infinite problem.
In our opinion, this dramatic shift shows why it’s important for these companies in healthy pension funding situations with plans whose deficits are levered relative to the balance sheet to increase their contribution rates if financially feasible. Our research show that just a small increase in contribution rates can significantly improve the stability of their corporate plan—significantly reducing the risk of permanently jeopardizing their funding goals.
With this mind, we encourage companies that have seen an increase in corporate cashflows to consider increasing contributions in the short-term. At the end of the day, paying now instead of paying later often makes for a more comfortable experience, and ensures greater stability for a plan.
5. DC plan sponsors: Consider adopting a multi-manager structure
Most defined-contribution (DC) plan sponsors have read countless studies that show how having too many investment options typically leads to poor investment decisions by participants. If a committee’s objective is to successfully lead participants to well-funded retirements, then we believe its primary duty is to provide limited choices—all of which create a high likelihood of a successful outcome.
Importantly, though, collapsing and consolidating options doesn’t mean you need to remove diversification. As a plan fiduciary, you may like the large cap growth, core and value funds in your plan, and participants would certainly benefit from both the opportunity to diversify and access to quality managers with different investment styles. But how? Enter a multi-manager approach.
In DC plans, a multi-manager structure allows for a limited set of investment options stocked with high quality and diverse strategies.
While most investment committees for large defined contribution plans have embraced multi-manager structures for years, we believe plans of all sizes should evaluate this as an alternative to single manager portfolios. Part of the rationale for this interest is that managers focus on different areas of the market, and diversifying among managers within one solution can provide a smoother ride for plan participants. Exposing participants to the idiosyncratic risk of a single manager is best avoided by building a multi-manager fund. We encourage DC plan sponsors that haven’t explored this alternative structure to consider doing so in 2025.
The bottom line
Unfolding amid an uncertain backdrop, 2025 has the potential to be a year rife with change. We believe the months ahead may present a myriad of opportunities and challenges for investors—and that those who are better prepared are more likely to progress toward their investment goals. Consider reaching out to your trusted investment partner and discussing some of the issues detailed above.
Disclosures
These views are subject to change at any time based upon market or other conditions and are current as of the date at the top of the page. The information, analysis, and opinions expressed herein are for general information only and are not intended to provide specific advice or recommendations for any individual or entity.
This material is not an offer, solicitation or recommendation to purchase any security.
Forecasting represents predictions of market prices and/or volume patterns utilizing varying analytical data. It is not representative of a projection of the stock market, or of any specific investment.
Nothing contained in this material is intended to constitute legal, tax, securities or investment advice, nor an opinion regarding the appropriateness of any investment. The general information contained in this publication should not be acted upon without obtaining specific legal, tax and investment advice from a licensed professional.
Please remember that all investments carry some level of risk, including the potential loss of principal invested. They do not typically grow at an even rate of return and may experience negative growth. As with any type of portfolio structuring, attempting to reduce risk and increase return could, at certain times, unintentionally reduce returns.
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