What was the most interesting/surprising development of 2012?
Belgrove: The debate/consultation regarding differences between the formulas used to calculate RPI and CPI inflation may seem esoteric and only of interest to statisticians, but in fact they have potentially serious consequences for pension schemes, index linked gilt holders in general, pensioners and the Exchequer.
Until there is more clarity it’s got a lot harder to make reasonably informed choices about hedging inflation. Double digit returns in corporate bonds may have surprised many this year – a continuation of this form seems unlikely.
Drewienkiewicz: For me, it was the extent to which markets were prepared to take the ECB on trust after Mario Draghi’s commitment to “do whatever it takes”. After two years of procrastination and disappointment it seemed that markets would need more evidence to shake off the uncertainty that had plagued them.
Green: The performance of equity markets has been surprising. They held up well over 2012 and market volatility has been low. It’s almost as if investors have been punch drunk trying to decide whether the market should be going up or down on the back of the seesaw of good and bad news on debt in Western economies. The ability for gilt yields to remain so low has been a huge topic over the year, although perhaps not that surprising. The other interesting story of the year has been inflation – fluctuation in levels of inflation and the opportunities this has created.
Kirton: Perhaps the most surprising development has been the relative calm of markets (I emphasise relative) in the face of continuing crisis in Europe and disappointing growth in the UK and US.
What will be the key areas of interest for institutional investors in 2013?
Belgrove: Underfunded and fast-maturing DB schemes still need significant returns. The hunt for yield and uncorrelated returns that has been a feature of recent years will continue. Extending financial hedging at reasonable value will also be of key interest. Although government yields will eventually rise at some point there may be little immediate relief notwithstanding a UK pause in QE. Meanwhile, pension schemes are under pressure to stay on track with their flight plans. The various developments in so-called smart beta present some interesting new choices for investors. Cost management remains an important consideration of net return generation.
Emerging markets are still arguably strategically under-represented and recent price softness might see fresh opportunities to invest in a balanced way. Finally, a few niche structured credit ideas represent value relative to standard investment grade credit opportunities where risks maybe now point to the downside.
Drewienkiewicz: A lot of the key areas of focus in 2012 are likely to stay important in 2013, from the US fiscal outlook to the development of the European situation. Another write-down in Greece will be required at some stage, and it seems virtually certain that this time round the ECB will have to participate. In addition, many investors will feel the impact from derivative and banking regulations which come into effect in 2013. It depends on how markets evolve and whether the credit spread rally that we have seen so far this year can sustain itself or even continue. At present, it appears that investors are being paid an outsized “illiquidity premium” to invest in bilateral or private lending contracts that are not freely tradable, when compared to the returns available on comparable traded instruments.
For these types of strategy to garner widespread interest we will need to see some downward evolution of fees.
Green: Quantitative easing. Next year could see some real impact from QE if economies are not flattened by the various concerns in the USA, Europe and China. QE is leading to more money in the system, which is being invested in assets. As an institutional investor, you would say steer clear of anything the US retail investor will be chasing and try to get access to private markets without giving up too much in transparency and liquidity.
The outcome of the US fiscal cliff in particular may set the tone for the year. This coupled with economic news as to whether there are firmer grounds for believing in a sustained recovery may see a shift in interest rate policy from “lower for longer” to some visible signs that interest rates will at some point begin to rise.
The outcome of the Consumer Prices Advisory Committee review on inflation may also see pension funds begin to address their inflation risk. Investors will continue to seek opportunities with sensible yields – with interest rates remaining low, and many income plays having performed well in 2012, this is likely to mean allocations to markets where some premium can be achieved for illiquidity, such as private corporate and property debt markets and infrastructure debt. On the risk reducing side, we expect LDI hedging strategies to see expansion into longevity swaps.
Kirton: Coping with the effects of de-leveraging while seeking out growth where one can find it will remain key areas of interest in 2013. Deleveraging processes take many years to complete, with considerable scope for policy errors and uncertainty along the way. Of particular concern is the seeming expense of ‘least risk’ assets such as government bonds. This and the general low economic growth environment will continue to encourage investors to broaden both risk reducing and return-seeking portfolios.
It is apparent that institutional investors are already prepared to invest across the broadest range of strategies and asset classes. This ought to encourage continued innovation by the investment management industry. In particular, we see further scope for innovation in the diversified growth space and in forms of absolute bond management. We also expect interest in fiduciary management solutions to continue to grow.
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