Equity market will drift for the next three to five years. Or so says a survey of 90 large pension and other institutional funds, together with a number of global fund managers, by Mercer Investment Consulting.
The consultancy, which recently surveyed almost 300 members of the investment industry on their expectations and investment intentions, says a majority of respondents believe equity markets will be slow to recover and that over half (52 per cent) expect dull market conditions over the next three to five years. However, only a small minority believe equities will remain subdued for longer than that.
Over the more optimistic five to ten year horizon, respondents thought Asia Pacific (excluding Japan) and emerging equity markets offered the best growth prospects. The survey identified considerable concern over the outlook for equity markets in North America and western Europe. Asked to rank markets in order of attractiveness, the respondents plumped for Asia Pacific (excluding Japan) and emerging markets. Fund managers in particular expressed pessimism about the US equity market, which they still see as expensive, despite the sharp fall in prices over the last three years.
On the other hand, the survey found minimal appetite for a substantial shift into bonds, despite the attractions in terms of liability matching. Only 15 per cent of funds foresaw a substantial increase in bonds, despite the widespread closure of UK defined benefit pension plans. Around 30 per cent of the fund investors intended to keep faith with equities and, of those that do intend to reduce their equity exposure, three-quarters (74 per cent) favoured only a modest decrease of up to 10 per cent over the next 12 months.
“The results appear to give the lie to suggestions that pension funds and other institutional investors are poised to dump equities in substantial quantities, progressively or in the wake of any ‘bounce’ in equity markets,” says Andrew Kirton, UK Head of Investment Consulting at Mercer. “Whatever the longer-term merits of government bonds as to liability matching, the lowest yields in a generation are putting off investors big-time.”
However, one in three survey respondents did expect to diversify their equity risk by investing in other asset classes. Property and hedge funds together with higher yield bonds and emerging market debt were voted as popular alternatives to equities. In contrast, private equity appears to remain relatively unappealing to investors.
In the light of this appetite for alternatives, it is not surprising to find that the vast majority of funds and investment managers (89 per cent) think benchmark hugging by investment managers is an issue. A similar majority (87 per cent) thought fund managers have a tendency to stick rigidly to benchmarks. “In this climate, where equity markets have fallen over 50 per cent relative to liabilities during the last three years, pension funds are particularly concerned about benchmark hugging,” says Andy Green, Head of Investment Strategy at Mercer. “Even the upper quartile equity managers who may have outperformed indices by as much as 10% over that period are still 40 per cent down on liabilities.”
To discourage benchmark hugging, many investment managers favour relaxing risk tolerance, says Mercer, though this approach is less popular amongst pension fund investors who would like to see performance-related fees used. Both groups agree that adopting absolute return benchmarks is a potential solution.” Funds themselves appear sceptical that giving managers greater discretion over investment policy would solve the issue of benchmark hugging, as many managers fail to use the risk quotas they are given,” explains Green. “The more radical approach of shifting away from market index-benchmarks may be necessary to tackle the problem effectively.”
The survey was conducted at Mercer’s Global Investment Forum which took place on 26-28 March in London. Some 90 medium to large institutional fund investors, mostly pension funds, attended the event together with over 150 investment managers and around 60 consultants.