Institutional investors should have one eye on the opportunities that could arise from a tentative economic recovery and the other on managing the substantial risks that remain, according to a report from consultancy group Mercer.
Mercer expects structural changes such as urbanisation and the desire for sustainable growth to provide new investment avenues. The consultancy also suggests that investors such as treasurers with excess liquidity and “the financial elbow room to explore a number of investment avenues” should seek to capitalise on their flexibility.
“Although uncertainty continues to hover over the global economy, heightened by the degree of policy experimentation, there are grounds for believing that some lifting of the gloom will occur in 2013,” said Andrew Kirton, global chief investment officer for Mercer.
“‘Safe haven’ assets are still pricing in at the same subdued levels and yet the sense of crisis has abated. If the corporate and private sector state of mind shifts gear from no growth to low growth, this bodes well for the performance of risk assets such as equities, and may trigger competitive behaviour and improving economic conditions. Wage restraint, corporate restructuring and an improving credit environment in parts of the West may all also signify some revival of market spirits.”
According to Mercer, while a ‘more of the same’ scenario might apply to Europe, and possibly the UK, there are indications that 2013 will see broader growth, spurred by improving economic conditions in China and the US, and activity going from strength to strength in many developing countries.
“Differentiated economic activity between countries will provide good opportunities for bond and currency managers,” said Divyesh Hindocha, global director of consulting in Mercer’s Investments business. “The corporate sector is awash with liquidity and, while this may not get spent immediately, it provides a solid foundation for any recovery.”
“Some companies will prosper in this environment by making the right decisions and others will struggle, making for a fertile environment for active management.”
Mercer is recommending that clients adopt a six-point investment strategy, as follows:
- Maintain broadly diversified asset portfolios: These will prove robust and resilient in the face of potential volatility but also capture value arising from the revival of economic growth in the Western world. This tends to favour a variety of growth and real assets including equities, real estate and growth fixed income opportunities, over safe-haven assets. Exposure to a wide array of different return drivers is preferable to running a narrow spread of positions.
- Hedge against inflation: Starting the process of building some inflation sensitivity into portfolios will protect against the possibility of unconventional central bank policies resulting in an increase in inflation expectations.
- Consider reducing commitment to ‘safe haven’ assets: While government bonds may be held for hedging or liability-driven reasons, investors should be clear on the investment case, given that the prospects for positive returns are limited.
- Improve shareholder engagement: Investors should use ownership rights to ensure that they are receiving a fair share of the returns generated by their capital. Investment managers should be encouraged to undertake meaningful engagement with the companies in which they invest.
- Avoiding unnecessary turnover and manage capital efficiently: Any ‘efficiency drive’ ought to include consideration of whether potential returns are being left on the table. Long-term investors might, for example, consider the merits of locking-in a portion of their fund to ‘earn’ an illiquidity premium.
- Flexibly manage portfolios: Institutions should have the courage, and the governance structures and processes, to manage their portfolios flexibly. Direction should be changed if necessary in response to events.
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