Fund managers cautious about 2012

Euro zone instability seen as main risk to global recovery; positive signs from the U.S. fuel optimism

New York and London, February 15, 2012 — Fund managers have turned significantly more cautious about the prospects for world growth and investment returns, according to a global survey of investment managers conducted by global professional services firm Towers Watson (NYSE, NASDAQ: TW). The findings are in contrast to last year’s survey when managers expected the recovery to remain on track and were bullish on public equities and emerging markets.

Carl Hess, global head of investment at Towers Watson, said: “The global economic recovery remains as elusive and fragile as ever, set as it is against the unavoidable facts of extreme indebtedness in the Western world and weak and uncertain prospects for growth in most markets. The second half of 2011 was a reminder that these fundamentals hadn’t gone away and have clearly influenced managers’ outlook for 2012. As such this influential group of investment managers have shifted from expecting a continuing path to recovery and the avoidance of a double-dip recession in some markets, to anticipating a more volatile and patchy period defined by increased levels of risk, some growth and significantly lower returns. Their optimism from last year, and the year before, is replaced by a less sanguine view about investors’ propensity to take risk in 2012, with managers’ significantly reducing the returns they expect from risky assets. A further indication of the change in sentiment from the past two years is their view that most economies are expected to have significantly lower growth in 2012 than they had expected in prior years.”

The global survey, which was conducted at the end of 2011, reveals investment managers’ renewed concerns about recession and financial risks, driven by slower than expected economic recoveries in most developed markets and nervousness around the potential implications of the Euro zone sovereign debt crisis. The survey, which includes responses from 114 investment managers (with AuM of US$7.8 trillion for institutional investors and US$1.9 trillion for retail investors) again noted the Euro zone crisis as the main risk to global economic stability, highlighting an expected slide into recession in some countries, including the UK, during 2012 and the prospect of sovereign default. They view Greece as being the most likely to default, necessitating debt rescue and restructuring, followed by Portugal, while they expect contagion to other Euro countries as unlikely.

Carl Hess said: “Euro zone countries face highly political long-term structural reforms, as well as fiscal austerity, which will be a tremendous challenge to implement, pushing out further any real global recovery. Politics have become enmeshed in the financial world since the global economic crisis began and managers have justifiably identified this as the top issue for them.”

The managers expect U.S. economic prospects to continue improving, although slower than the historical average, while Japan is expected to recover from last year’s tsunami-induced recession to maintain moderate growth in the next few years. While most managers expect China to grow at a slower pace, albeit robust and sustainable, some suggest that it may retreat modestly in terms of economic competitiveness. Many managers view the U.S. as the region with the most rewarding investment opportunities in 2012.

Carl Hess said: “While there are some positive economic signals coming out of the U.S., driven largely by government policies such as tax incentives to help consumers and the Fed’s highly accommodative monetary policy, these cannot continue indefinitely. If the economy doesn’t develop some of its own momentum and unemployment doesn’t reduce, 2012 and 2013 could be very challenging particularly as much of the current stimuli would have run its course. The policies are clearly intended to stimulate growth and address the massive U.S. fiscal deficit, however, they bring considerable political, and some inflationary, risk.”

In contrast to last year, managers expect more modest equity returns in 2012, with significant downside risks, but have particularly depressed expectations for the U.K. and Euro zone. In addition, they anticipate equity returns to remain muted over the long term, likely below the historical average. They expect equity markets in 2012 to deliver returns of 8.0% in the U.S. (10.0% in 2011); 5.0% in the U.K. (10.0%); 6.0% in the Euro zone (7.0%); 7.0% in Australia (10.0%); 5.0% in Japan (6.0%); and 7.8% in China (10.5%). Expected equity volatility for 2012 is in the 15% to 25% range, somewhat higher than longer-term averages. Despite ongoing economic uncertainty, most managers hold overall bullish views for the next five years on emerging market equities (75% vs. 85% in 2011), public equities (72% vs. 79%) and private equity (55% vs. 54%). For the same time horizon, the majority remain overall bearish on nominal government bonds (77% vs. 79%) and money markets (43% vs. 46%). A significant shift is the rise in managers now feeling bullish about commodities (56% vs. 35% in 2011) and high-yield bonds (59% vs. 34%).

Carl Hess said: “While it would be a stretch to say this bullishness about risk assets is misplaced optimism, we would still caution investors, particularly pension funds, against taking on more risk, even in light of ongoing market rallies. The move into positive territory for many markets this year is helpful but largely reflects central bank liquidity and may not prove sufficiently sustainable to justify a strategic move back into risk assets or indicate a cyclical recovery. While developed market equities might be moderately attractive as of the beginning of 2012, they are pricing in only modest expectations for real earnings growth, as political tail risks remain. This makes emerging market equities a preferable re-entry point and the same goes for currencies and debt, assuming limited exposure to Euro zone sovereigns in the case of the latter.”

According to the study, real GDP growth expectations for 2012 range from 0% in the Euro zone (1.8% in 2011) to 8.0% in China (8.9%) followed by 3.0% in Australia (3.2%), 2.0% in the US (3.0%), 1.0% in the UK (2.0%) and 1.5% in Japan (1.5%). Managers’ ten-year GDP growth forecasts broadly match their one-year view and are below historical trends. The survey shows that managers expect unemployment to remain a tough challenge for some Western economies, especially for the Euro zone countries implementing fiscal austerity measures, while they expect a soft landing in China. According to managers, expansionary monetary policies are expected to hold in 2012, with exceptionally low interest rates in some Western economies, but to gradually tighten in the years ahead. Inflation is viewed as a moderate risk, but with a wide range of possible outcomes, tending to the upside for years to come. Managers have little concern about the fiscal situations in Canada, Australia and China.

Turning to five-year views on bonds, most managers (63%) still hold overall bullish views on emerging market debt, although down from 76% in 2010 and most (77%) remain bearish on the prospects for nominal government bonds. Most managers hold neutral or negative views on the prospects for inflation-linked government bonds (79%), while high-yield bonds are viewed more positively (59% are bullish).

Carl Hess said: “After several years of very easy monetary policy and ongoing quantitative easing in the US and UK, this tool has had the effect of shaving off around 50 basis points from the long end of the yield curve. As a result longer-term bonds in these markets are less attractive than they once were although their safe-haven status probably compensates for this. Last year markets were anticipating a gradual increase in policy rates; that expectation has largely disappeared in most markets, particularly in the Euro zone where they seem headed towards zero, as any recovery looks as fragile and bumpy as ever.”

Other findings from the survey include:

• In 2012 managers expect unemployment to be higher than in the recent past in the U.K. (8.5%) and Euro zone (10.6%) while they are expecting a mild improvement in the U.S. (8.5%)
• They are expecting improved unemployment figures in most markets, excluding China and Japan, during the next ten years, although some, mainly Western countries will stay fairly high by historical averages: Euro zone (9.0%), U.K. (7.0%), U.S. (7%) and Canada (6.5%).
• The managers’ consensus is that crude oil is expected to reach US$100 a barrel this year (they expected US$93 in 2011 and US$80 in 2010) and US$120 a barrel in the next ten years (up from US$103 last year).

Towers Watson Investment

Towers Watson Investment is focused on creating financial value for the world’s leading institutional investors through its expertise in risk assessment, strategic asset allocation and investment manager selection. It is a division of Towers Watson’s Risk and Financial Services business, and has over 700 associates worldwide and assets under advisory of over US$2 trillion.

About Towers Watson

Towers Watson (NYSE, NASDAQ: TW) is a leading global professional services company that helps organizations improve performance through effective people, risk and financial management. The company offers solutions in the areas of employee benefits, talent management, rewards, and risk and capital management. Towers Watson has 14,000 associates around the world and is located on the web at www.towerswatson.com.