The year ahead
This month’s Off the Record survey asked European pension funds for their outlook for 2011, and received varying views and concerns.
Some 29% of respondents stated they have a chief economist, head of research or committee producing a macroeconomic view for strategic and tactical asset allocation, while 38.5% do not. The remaining 32.5% rely on investment consultants or other advisers for this. One Dutch fund stated they use a combination, commenting: “The fund has external economic advisers, but combines this with [its] own macroeconomic views for the strategic asset allocation.”
The majority of respondents (35.5%) felt the biggest credible threat to the global economy or financial markets in 2011 was a European sovereign defaulting, restructuring or rescheduling its external debt. This was most closely followed (23%) by the fear that the break-up of the euro-zone would begin to look inevitable.
Some 13% felt populism could take hold in US and European politics, while an equal number (9.5%) were concerned by either a developed economy currency crisis, China’s inflation running out of control and/or the country committing a policy error, and other factors such as an international debt crisis.
Almost 60% of respondents expected their domestic short-term interest rates to be higher, but only by 1% or less, at the end of 2011. A German fund commented: “[The] ECB’s exit policy remains ambiguous, however, [it] is ready to raise short-term interest rates earlier than The Fed.” A Belgian scheme added: “It’s obvious that inflation is rising and that the ECB will be obliged to intervene.”
Three respondents felt domestic short-term interest rates would be more than 1% higher than they are today at the end of 2011, while just over 30% thought they would remain the same as today. “We are not very positive about the economy on the short term and expect the ECB to keep rates low,” said a Dutch fund.
Respondents were fairly evenly split regarding how they expected their domestic yield curve to have moved by the end of 2011. Some 32.5% felt it would have moved very little, with a Swiss fund stating it would be “volatile, but end the year almost unchanged”. Fewer (29%) felt that it would remain steep or steepen further from its current position. A Spanish fund said: “[As] we don’t expect an increase of inflation and stable short rates, a slight increase in long rates could be possible.” 22.5% thought their domestic yield curve would rise significantly, while 16% thought it would flatten.
Some 56.5% of respondents said they would not aim to match interest rate risk with assets, while 36.5% stated they hedged part of their interest rate risk and just 7% hedged 100% of their interest rate risk.
A large proportion (48.5%) did not feel it was currently a good time to use assets to match interest rate risk in an LDI strategy, as bond yields are too low and assets are better employed seeking yield elsewhere. Some 17% thought now was a good time, while 10.5% also thought it was but would use swaps to avoid having to hold too much government bond risk. Meanwhile, 14% did not consider it to be a good time, but could not afford to take active risk against liabilities.
Almost 60% of respondents felt that current economic conditions made short-term, dynamic asset allocation more important. A French fund commented: “As there are no more safe havens in any kind of asset, it is more important to maintain a flexible approach.” Some 16.5% felt it to be essential, 10% less important and 16.5% irrelevant, distracting or useless.
A total of 83% either felt that economic conditions made diversification either more important or essential. A Finnish fund thought this was true, “especially for investors that have been focusing on EU/US assets. It is important to evaluate how the dynamics change in global markets on [a] long-term basis.”
Many funds have found the low interest rates of recent months to be very problematic. “We have had very little room to react due to the new restrictions imposed by the authorities,” stated a Danish fund. A Spanish fund added: “Low interest rates gives us a low visibility of our expected return, because our main investment is fixed income. So, we try to diversify and to invest in assets of higher expected return.”
Some 58.5% of respondents said their investment priority for 2011 was protecting the downside. This was followed by those funds hoping to take advantage of the upside (38%), to implement more tactical or dynamic asset allocation (31%), to de-risk (27.5%), and to implement strategies for a low-rates environment (24%).