Almost half of respondents to this month’s Off The Record survey felt that the biggest credible threat to the global economy or financial markets in 2012 was the euro-zone break-up beginning to look inevitable. “The risk of a break-up has consequences impossible to oversee and hedge. It is not unlikely anymore,” said a Dutch fund.
Six respondents were concerned about rising political populism, four worried that contagion could spread to core euro-zone bonds, while two respondents felt other issues to be a more pressing threat, such as a double-dip recession.
Despite all the gloom, just under half of the respondents thought that their domestic short-term interest rates would be the same or lower in a year’s time, over half thought they would be higher - two of them by more than 1 percentage point higher. One Dutch fund cited “inflation”. But a Spanish fund spoke for the others when it stated: “As recession spreads, the ECB will be forced to act more like the Fed. Deflation, not inflation, will be the issue.”
And despite this split over short-term rates, half of respondents expected their domestic yield curve would have moved very little by the end of 2012, while a further seven said it might steepen further. Only two thought it would rise significantly or flatten. “Even though the domestic economy has good prospects based on oil revenues, we think the European recession will negatively impact consumer goods export,” commented a Norwegian fund.
Twelve funds thought that current economic conditions made shorter-term, dynamic asset allocation more important. “You must be protected for downside risk,” warned one UK fund. “High volatility downgrades the return/risk ratio and cash becomes an important piece of asset allocation,” said a Portuguese fund. “But cash has a very low yield, so dynamic asset allocation is important for coming back to risky assets.” However, almost a third felt it “irrelevant, distracting or useless” and one UK fund said that markets were “too volatile to do much more than an inspired guess”.
Over half of respondents believed that current economic conditions made diversification more important. A Swiss fund commented: “[In] times of uncertainty and possible binary outcome, it is important to diversify between and inside asset classes.” A Spanish fund said not everything will go bad, “especially for emerging markets and alternatives”. Still, four respondents thought diversification was “irrelevant or impossible to achieve” while two thought it was currently “less important” to diversify.
As in last year’s survey, most respondents (13) said protecting the downside was their main investment priority for the coming year. Unfortunately, the survey found seven out of 17 respondents were now convinced that there were no longer any safe havens apart from cash or, as one Swiss fund suggested, “family”.
There was some good news: the only asset class regarded as overvalued by our respondents (71%) was domestic 10-year government bonds. But even that was tempered by a lack of conviction about value elsewhere: the best results were for UK and European equities, which nine respondents (43%) thought under-valued.
“If the euro crisis could be solved, euro equity is undervalued and German bonds extremely overvalued,” said a Dutch fund. “However, we fear that the world could fall into a very serious recession and some countries even into a depression. In that case, equity is still fairly overvalued and German bonds may prove to be cheap.”
The same scheme summed up its plan for 2012: “[It is] most important to avoid unnecessary risks, keep an all-weather portfolio as much as possible, [and to] move very fast in case the situation in the world changes.”
Just under a quarter of respondents had a chief economist, head of research or committee producing a macroeconomic view for strategic and tactical asset allocation. Nine funds did not, while a third relied on investment consultants or other advisers.