What keeps institutional investors up at night?

The bad news coming out of Europe has slowed to a trickle over the past couple months, but institutional investors don't expect the good times to last. Seven out of 10 institutional investors cited fallout from Europe's sovereign-debt crisis as the most likely source of market volatility over the next two years, according to a survey released on Tuesday by Natixis Global Asset Management SA. What's more, 43% said the uncertainty on the Continent is the top issue keeping them up at night. As if on cue, Spanish 10-year bond yields shot up over 6% for the first time in a week and the euro fell to a two-week low against the dollar Wednesday morning. To fight against the expected increase in market volatility, which 82% reported having trouble dealing with, institutional investors increasingly are turning away from the traditional 60/40 stock and bond portfolio and adding less correlated alternative assets, according to the survey. More than three quarters of respondents said they consider alternatives essential to diversifying portfolio risk. “They're looking for smoother return streams and recognize that alternatives need to be in the tool bag to manage risk,” said Bob Hussey, executive vice president of institutional investing at Natixis. The smoother return streams do come at a price, though. Nearly two-thirds of institutional investors surveyed agree that lowering the overall risk of a portfolio means accepting lower returns. Coincidentally, more than 80% of institutional investors reported having difficulty meeting total-return objectives.