Fund managers are more optimistic about the prospects for equity returns in most markets, yet remain concerned about world growth and medium-term government bonds, according to a global survey of investment managers by Towers Watson.
The survey also highlighted the most important issues investment managers expect to face in 2014, which are government intervention, inflation, global economic imbalances and financial instability, with government intervention being a very significant concern for them in the next five years.
Matt Stroud, head of investment strategy, Americas, Towers Watson, said: "It is not surprising that managers have expressed such unease at developed market governmental intervention, including monetary, fiscal, legislative and regulatory measures — given the impact such developments as Quantitative Easing (QE) tapering, fiscal spending going into sequestration and the Volker Rule have had on global markets. The knock-on effects from some of these interventions, particularly QE tapering on some fragile emerging markets and the Volker Rule’s impact on certain over-the-counter markets (such as the corporate bond market) have been significant."
The global survey, including responses from 128 investment managers (the majority having institutional assets under management [AuM] above US$5 billion and retail AuM above US$1 billion) showed that (44%) of the respondents believe the investment strategies of their institutional clients will become more aggressive next year, up from a third of managers in 2013.
During the next five years, the majority of managers expect the world’s largest economies to experience mild growth, with the exception of the Eurozone, where they expect unemployment to remain in the low double digits in the short term and at a relatively high 9.5% in the medium term.
Stroud added: "During the last quarter of 2013, when this survey was conducted, developed market equities had performed very well, leading to improved consumer confidence. Toward the end of the year, there was revitalized growth in the U.S. and China, as well as growth acceleration in the U.K. and Japan. So while these are positive signs that have influenced managers’ outlook for 2014, the global economic recovery, while still somewhat fragile, is looking more sustained."
In contrast to last year, managers expect better equity returns this year in most markets, with the exception of the U.S. and China. They expect equity markets in 2014 to deliver returns of 6.9% in the U.S. (compared to an expectation of 7.0% in 2013), 7.0% in the U.K. (6.0%), 8.1% in the Eurozone (7.0%), 6.4% in Australia (6.0%), 7.3% in Japan (6.0%) and 8.4% in China (10.0%).
Most managers in the survey hold overall bullish views for the next five years on emerging-market equities (76% vs. 83% in 2013), public equities (78% vs. 78%) and private equity (59% vs. 53%). For the same time horizon, the majority remains bearish overall on nominal government bonds (81% vs. 80% in 2013), investment-grade bonds (58% vs. 47%), high-yield bonds (42% vs. 39%) and inflation-indexed government bonds (42% vs. 47%).
Stroud added: "The increase in participants who believe their institutional clients’ investment strategies will become more aggressive next year (44% vs. 34% last year) surprised us. This caught our attention, as we rated equities ‘neutral’ as of January 2014, as opposed to ‘moderately attractive’ a year ago, reflecting the change in our view of valuation levels year over year. Not to mention the capital flight we are seeing in certain jurisdictions, such as Turkey and South Africa, in response to shifting expectations around federal tapering. So the ‘buy’ side of this ‘risk on’ posture, which some might expect, calls for high selectivity, in our view."
In a significant shift from previous years’ studies, real GDP growth expectations for 2014 are now showing an upward trend and range from just above 1% in the Eurozone (0% in 2013), to 7.0% in China (7.5%), followed by 2.4% in Australia (2.5%), 2.4% in the U.S. (2.0%), 2.2% in the U.K. (1.0%) and 1.6% in Japan (0.9%). With the exception of China and Japan, investment managers’ medium-term GDP growth forecasts are slightly above their one-year view, and in the years ahead, they expect growth to slow in China, while Japan and Eurozone growth is expected to lag for years to come. U.S. economic competitiveness is expected to increase in the coming years, though most respondents feel it is likely to have a weak but manageable fiscal situation, with mild growth.
The survey indicated managers expect unemployment to remain a challenge for some Western economies, especially for Eurozone countries implementing fiscal austerity measures. According to managers, expansionary monetary policies are expected to hold in 2014, with exceptionally low interest rates in some Western economies, but gradually tighten in the years ahead. Inflation is viewed as a moderate, near-term risk, with some very concerned about long-term inflation risk in the U.S. and Europe.
Turning to 10-year government bond yields, managers predict yields stabilizing at historic lows in 2014, reflecting a mix of economic strengthening in key markets but with continued central bank asset purchases. Reflecting year-end 2013 yields in many countries, many managers are predicting yields on 10-year government bonds will increase, with predictions for the U.S. 10-year yield rising from 2.0% to 3.0%, mirrored by the U.K. (from 2.0% to 3.1%), the Eurozone (2.0% to 2.4%), Australia (3.3% to 4.1%) and China (3.8% to 4.6%). Managers are predicting a small drop in bond yields for Japan (1.0% to 0.9%).
Stroud added: "Managers are bearish on developed-market government bonds and investment-grade bonds, even with expectations that interest rates will not move much over the next year. Investors may find these asset classes less attractive due to current rate levels and central bank action, though respondents were also bearish on high yield, even more so than money market, perhaps reflecting the deterioration in valuation, as well as terms of certain ‘covenant-lite’ and ‘payment in kind’ deals during 2013."