The status of sovereign debt as a safe-haven investment has been put into question and the whole approach to bond investing may need to be revisited, according to Mercer, which has urged institutional investors to focus in the coming year on the ‘new realities’ of the global marketplace, which includes sufficient flexibility in their portfolios.
Mercer says in a “a world where the cost of borrowing for Microsoft is cheaper than the cost of borrowing for many sovereign developed countries, the whole approach to bond investing may need to be revisited”.
The global financial crisis of the past two years continues to reverberate throughout the investment markets, introducing a number of ‘new realities’ important to institutional investors as they consider their strategies for 2011, according to Mercer.
Andrew Kirton, global chief investment officer for Mercer said the new challenges underscore the need to focus on critical issues, consider the downside of any strategy, and set investment priorities that can behave robustly in a changing and uncertain investment environment.
“Although economic and financial confidence is tentatively returning to some Western countries, the crisis has wreaked havoc on a number of nations’ balance sheets, has disrupted the credit allocation process in Western economies, and added to the potential for global tensions,” he said.
In addition other ‘new realities’ set out by Mercer include:
- Major developing economies such as China and India are growing in economic strength and have expanded capital markets access, thus creating a two-speed world economy. In particular, the inexorable rise of China, paymaster to the US consumer and seeming new friend to Africa, emerging Asia and Europe, raises fundamental questions about changing world hegemony and economic might.
- Inflation is a growing concern with the prices of many commodities rising to levels not typically found at the start of an economic cycle. There are growing arguments for expecting greater inflation pressures in the next few years. This begs the question as to how robust investment portfolios are if an inflationary environment prevails.
- Reform of the financial system to avoid a repeat of the bailouts of 2008 is barely off the drawing board, and permanent fixes to tame the bump and grind of the world’s financial plate tectonics remain in their infancy.
- To achieve true diversification, arguably investors must broaden their horizons, a lesson learned in the global economic downturn when major equity and bond markets around the world moved in lockstep. Investors will be challenged to design portfolios that are forward-looking in nature and not biased to past successes.
In addition Divyesh Hindocha, global director of consulting for Mercer’s investment consulting business, said investors need to start focusing more attention on the longer term fallout and implications from the crisis and consider how to reflect this in their portfolios.
“Some of the outcomes have greater visibility, other less. This means ensuring that those managing investment portfolios retain the flexibility to respond to developments, and seek to ‘win by not losing’.
“The purpose will be to avoid the most adverse effects of locking into a strategy and having little flexibility when market conditions change. This is about being more global, having inherent hedges to control volatility, implementing dynamic asset allocation, and allowing more manager discretion around benchmarks.”
“Mercer believes that the new realities of the investment environment will create many opportunities, but that they also call for fresh thinking, the ability to make quick decisions, and resilience in the face of a distinct lack of certainty,” he said.