Despite their continued uncertainty over the outlook for global economic improvement in 2015, fund managers remain optimistic about investments in equities and alternative assets over the long term.
However, managers continue to express concern over returns from government bonds, according to the Global Survey of Investment and Economic Expectations conducted by Towers Watson. The survey also found that respondents expect currencies to become a more important factor in returns and inflation to rise over the long term.
The survey showed that managers’ ongoing uncertainty over the world economy is having an effect on how they view portfolio positioning over the next year. In fact, only one-quarter (25%) believe the investment strategies of their institutional clients will become more aggressive this year, a sharp drop from last year, when nearly half (44%) said their clients would invest more aggressively. Conversely, more than one-third (34%) believe their clients will invest more conservatively, an increase from 29% in 2014.
“Our view is that global inflation markets are pricing in an extension of the current disinflationary environment, or the inflation risk premium is depressed or both,” says Matt Stroud, head of delegated portfolio management, Towers Watson. “Given the slack in major developed economies, we believe market-implied levels of inflation are broadly consistent with our outlook. In addition, risks to our forecasts remain skewed to the downside.”
Unlike last year, when managers in most markets projected better equity returns, this year, expectations are sharply divided by market. Managers expect equities to deliver the strongest returns in Japan (9.0%), China (8.5%) and the US (7.2%). In contrast, they expect lower returns in Australia (4.9%), Canada (5.4%) and Switzerland (5.7%).
The survey showed most managers remain bullish for the next five years on emerging-market equities (70% vs 76% in 2014), public equities (73% vs 78%), infrastructure (60% vs 53%) and private equity (55% vs 59%). For the same time horizon, the majority of managers are bearish on nominal government bonds (83% vs 81%), investment-grade bonds (53% vs 58%) and high-yield bonds (50% vs 42%).
“We believe equities will provide reasonable returns as easy monetary policy and mediocre growth combine to offer a relatively supportive environment, although valuations will vary across markets,” says Stroud. “Short- to medium-dated sovereign bonds will provide reasonable returns as priced-in cash rates continue to be revised lower. Conversely, credit markets appear vulnerable to downside economic risks from an economic perspective, and from creeping leverage and weaker underwriting standards. Low starting yield spreads fail to provide much cushion against anything other than a benign outcome.”
When asked to identify their most critical investment issues over the next five years, six in 10 (61%) respondents cited government intervention, including monetary, fiscal, legislative and regulatory measures. More than four in 10 (42%) identified global economic imbalance as a critical issue, followed by inflation (35%). Managers also identified asset allocation and risk as the two most critical issues facing their institutional investor clients.
“It’s not surprising that a majority of investment managers are concerned over governmental intervention, especially in light of last year’s end to the Fed’s bond-buying program and anticipation of the European Central Bank’s announcement of quantitative easing,” says Stroud.
The survey noted that 61% of respondents see the US dollar as a rewarding investment opportunity. Managers expect the dollar to maintain its strength, demonstrating a belief that currencies will play a key role in total returns and the management of assets on the back of 2014’s currency volatility. This is consistent with managers’ expectations of monetary policy’s continued prominent role in investment analysis over the next five years.
For the second straight year, real GDP growth expectations are showing an upward trend and range from just above 1% in the Eurozone for 2015 (1% in 2014 also), to 6.7% in China (7.0%), followed by 2.5% in Australia (2.4%), 2.7% in the US (2.4%), 2.5% in the U.K. (2.2%) and 1.3% in Japan (1.6%). When looking ahead 10 years, managers project the strongest GDP growth in China (5.7%), with softer growth in the Eurozone (1.5%) and Japan (1.2%).
Many managers are predicting 10-year government bond yields will rise in 2015, with predictions for the US rising to 2.8% (from 2.1% as of year-end 2014), the U.K. to 2.8% (from 1.8%), the Eurozone to 1.4% (from 0.5%), Australia to 3.6% (from 2.7%), China to 4.3% (from 3.7%) and Japan to 0.9% (from 0.3%).
The survey revealed significant differences in managers’ short- and long-term outlook on unemployment for different markets. Managers expect unemployment to hover above 10% in the Eurozone (10.5%) this year and improve only slightly in 10 years (9.1%). In contrast, they expect unemployment to average 3.6% in Switzerland and 3.5% in Japan this year, and slightly higher in 10 years (3.8% and 3.7%, respectively).
“Interestingly, many managers believe the most important attribute for investment success going forward is active management. While we agree that active managers can add significant value, especially in an environment where valuations are heavily impacted by government actions, we also believe the appropriate response to an uncertain future is to emphasise portfolio diversity,” says Stroud.
