Structural changes in financial systems and a shift in economic power will see a growing disparity in the investment performance of institutions over the next 10 years, according to a McKinsey & Company report.
"We believe that the next decade will be far different from the last and will lead to a dichotomy among institutional investors, with increased separation in performance among investment institutions," the authors of the report, "The Best of Times and the Worst of Times for Institutional Investors", write.
"Many institutions are fundamentally adapting their business models to post-crisis realities, while others tweak at the margin, without addressing the fundamental issues at hand - only time will tell which strategy will lead to superior performance."
The authors argue that historical rules of thumb and mean reversion strategies will be challenged over this period due to a number of secular shifts.
They say they expect economic growth to shift from the developed to the developing world, but profiting from this shift would not be straightforward.
"Equity returns show very little correlation with economic growth in the near and medium term," they say.
"Furthermore, valuation gaps in accessible equity markets have effectively closed and some markets are at risk of overheating. In this context, a simple passive index investing approach could well yield disappointing results."
McKinsey says it also expects market bubbles to occur more often and to be more severe, while investors seeking to hedge these tail risks will quickly find that insurance has become exceedingly expensive.
De-leveraging in developed economies, increasing government intervention in markets, uncertainty in the supply and demand balance of natural resources and industry transformation through new technologies and margin shifts will further add to challenges for institutional investors to find profitable transactions.
But the authors do offer some guidelines for navigating future turbulence.
They advise investors to focus on absolute return objectives, rather than risk-adjusted returns, to better manager their return objectives and extend their investment horizon.
The authors also make the case for a more strategic approach to asset allocation, considering thematic approaches, increasing allocations to alternatives and avoiding index strategies in emerging markets.
"Most institutions agree that the emerging markets free lunch is over, and a passive 'me too' approach to investing in these markets is bound to lead to disappointing results," they say.
Finally, they argue for better governance structures, better alignment of risk management and innovation of investment strategies, and a greater emphasis on research.
