Mercer predicts top ten investment trends for 2010

21/09/2010
Provided by Mercer. The information in this article does not necessarily reflect the views of the Trustee.

The investment landscape has changed irrevocably since the Global Financial Crisis and investors will be wise to ensure their investment strategies reflect the lessons learned from this period. Going into 2010 Mercer highlights what it sees as the top ten investment trends that investors should critically examine in order to successfully manage their investment portfolios for long-term outcomes.

  1. Superannuation legislation will force change in the way we look at retirement and how retirement savings are invested
  2. A weaker global banking system will create opportunities for private credit
  3. Emerging market growth will outstrip developed markets, but equity markets may have priced this in
  4. Environmental, Social and Governance (ESG) factors will continue to rise on investors' radar
  5. Investors will critically examine their investment strategies in the context of evolving deflation/inflation risks
  6. Dynamic Asset Allocation (medium-term asset allocation tilts) will be de rigueur to capture market mispricing in the medium-term
  7. Investors will undertake more due-diligence on hedge fund strategies
  8. The big “macro” moves may be behind us - time to become “micro”?
  9. Super funds will question the role of illiquid assets in their portfolios
  10. Diversification will remain key



Simon Eagleton, Business Leader of Mercer's investment consulting business in Australia and New Zealand examines the top ten investment trends for 2010 more closely:


1. Superannuation legislation will force change in the way we look at retirement and how retirement savings are invested

By mid-2010, both the Cooper and Henry Reviews will have presented their final recommendations on Australia's superannuation system. This may mean a radical re-visitation of super funds' investment strategies, and we predict renewed interest in target date approaches and their associated investment strategy glidepaths. Product innovation for the post-retirement phase, or a whole-of-life investment approach will also continue. The accountability of the Boards and Trustees of super funds will also increase as members demand greater security of their retirement incomes.


2. A weaker global banking system will create opportunities for private credit.

Who will fill the credit gaps created by the decline in the number of banks and their capacity and willingness to lend? As global economies recover, businesses are seeking new funding and roll-over financing. Private debt lending rates are already in their low to high teens and at these levels, the supply of credit will be filled by private creditors and investment opportunities in private equity and private credit will grow accordingly.


3. Emerging market growth will outstrip developed markets, but equity markets may have priced this in

The IMF predicts slow growth of 1.3% in advanced countries in 2010 will be out-stripped by growth of 5.1% in developing countries and a very rapid 7.3% in developing Asia. China and India will be at the forefront of Asian growth but Korea, Indonesia and Vietnam will also grow fast. Looking further ahead, this pattern of faster growth in the Asian region is expected to continue.

However, there has already been a surge in investment in emerging market equities, aided by the availability of ETF funds to retail investors. China's currency peg to the US dollar has resulted in very low interest rates relative to nominal GDP growth, and there is a risk that some emerging markets could move beyond fair valuations into “bubble” territory.


4. Environmental, Social and Governance (ESG) factors will continue their rise on the radar screen

As emerging markets become wealthier they will not continue to tolerate current pollution levels. They will also attempt to reduce the energy dependence of their growth and green house gas emissions. A precipitating factor is that investors and their investment managers will need to integrate ESG factors into their process or be at risk of being blindsided. Developing legislation on issues such as climate change will also help to cement ESG into investment agendas.


5. Investors will critically examine their investment strategies in the context of evolving deflation/inflation risks

Although the threat of sustained deflation in the US and Europe is diminishing, investors are concerned the accompanying policy response risks a renewed outbreak of inflation. Faced with spiralling public sector debt ratios, and growing long-term budgetary obligations, investors have become sensitive to the possibility some governments may seek to 'inflate' their way out of debt. We anticipate few governments will risk such a destabilising option, but will need to quickly begin articulating measures to bring debt down to more manageable levels. In 2010 investors are likely to begin demanding more credible fiscal exit strategies and begin to discriminate more carefully between leaders and laggards. For investors who believe some governments will still need to eventually print money in order to avoid default, we note typical inflation protection strategies are no longer especially cheap. We continue to emphasise that the risk of deflation has not yet been fully eradicated, particularly if governments can no longer guarantee the funding obligations of financial institutions.


6. Dynamic Asset Allocation (medium-term asset allocation tilts) will be de rigueur to capture market mispricing in the medium-term

Strategic asset allocation has traditionally been based on an assumption of long-term market equilibrium, but in practice markets rarely reflect 'fair value'. Dynamic Asset Allocation (DAA) can exploit deviations from long-term averages to deliver improved returns and sound risk management. This approach replaces the 'set and forget' school of thought of strategic asset allocation.


7. Investors will undertake more due-diligence on hedge fund strategies

Hedge funds took a major battering in the maelstrom of the financial crisis, with estimates of up to a third of the industry winding-up. In 2010 investors will re-think their approach to investing in hedge funds seeking improved transparency of underlying risk exposures, less 'directionality' (or sensitivity to market movements) and more equitable fee bases.


8. Super funds will question the role of illiquid assets in their portfolios

Many illiquid investment strategies such as unlisted or direct property, infrastructure, private equity and debt, and a number of other alternative investment strategies can provide access to diversifying - and in some cases unique - sources of return. Such investments can therefore be highly desirable as part of a well-designed investment strategy. However the GFC created significant pressure on those super funds whose heavy reliance on unlisted assets created a liquidity mismatch between their obligation to meet members' switching or rollover requests and the ability to realise assets for cash at short notice. We expect such funds to reduce their strategic allocations to illiquid assets in the future. At the same time, other funds will continue to look for diversification opportunities including in unlisted assets.


9. The big 'macro' moves may be behind us - time to become 'micro'?

Both 2008 and 2009 have been characterised by massive swings in market valuations, as unfolding economic events drove investors to the brink of despair before hope and confidence was restored. In this environment, risky assets (equities and credit) were borne on waves of liquidity flows, and 'micro' analysis of individual companies' prospects seemed at times irrelevant. As the recovery matures it seems likely that investors will become more discriminating, and country, sector and stock picking abilities may once more become pre-eminent.


10. Diversification will remain key

Traditional investment strategy of diversification abjectly failed to protect investors during the Global Financial Crisis. Misunderstanding the underlying – and interconnected - risk exposures saw many investors unprepared for the magnitude of losses experienced in early 2009.

When faced with uncertainty, diversification will continue to be the primary tool available to investors to improve their chances of investment success. The key lesson here however is to seek genuine diversification of underlying return sources through properly identifying the risks involved, and to spread portfolios across as many lowly correlated assets as possible.

We expect to see continued investor interest in a range of alternative assets classes and strategies as a result of this, particularly ones that are less linked to traditional market movements. These include insurance-linked investments such as catastrophe bonds, aircraft leasing investments, agricultural investments and social infrastructure. We also see further interest in non-traditional equity strategies such as low volatility products and structured strategies that use derivatives to limit extreme downside risk.


 

This information has been prepared by Mercer Outsourcing (Australia) Pty Ltd (MOAPL) ABN 83 068 908 912, Australian Financial Services Licence #411980. Any advice contained in this document is of a general nature only, and does not take into account the personal needs and circumstances of any particular individual. Prior to acting on any information contained in this document, you need to take into account your own financial circumstances, consider the Product Disclosure Statement for any product you are considering, and seek professional advice from a licensed, or appropriately authorised, financial adviser if you are unsure of what action to take. "MERCER" is a registered trademark of Mercer (Australia) Pty Ltd ABN 32 005 315 917. Copyright 2012 Mercer LLC. All rights reserved.
 

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