A round-up of of the issues industry experts believe will be making headlines in 2015.
Bonds: individual stock-picking is key
Bond yields will stagnate in the eurozone and Japan and only rise modestly in the US and UK, according to asset managers.
Amundi Asset Management said the year ahead would be characterised by increasingly disparate yields and lower currency volatility, with dollar-denominated emerging assets flourishing on the back of a rise in the currency.
But it warned assets tied to commodities, such as currencies or the debt of commodity-exporting economies, were not well-positioned to benefit in 2015. Investors will need to be more selective about securities as a result of a broader dispersion of spreads stemming from an increase in the divergence of fundamentals, it added.
Similarly, Hermes Investment Management said security selection in the credit market has “rarely been more vital”. Hermes co-heads of credit Fraser Lundie and Mitch Reznick said: “Lower valuations and diminished extension risk, which followed a significant summer repricing, provide better stock-picking opportunities.”
However, they added: “Both duration and convexity risk remain significant for large parts of the credit market, given the impending normalisation of US Federal Reserve monetary policy and the large execution risks associated with this. Secondary market illiquidity may exacerbate such risks. 2015 will be a year when picking the right securities – whether cash or synthetic – within issuers’ capital structures will be vital to generating outperformance.”
Elsewhere, Schroders head of multiasset investments Johanna Kyrklund said. “We believe Janet Yellen, chair of the Federal Reserve, is not under any immediate pressure to raise rates. In this environment UK government bonds provide a hedge against a further slowdown in growth momentum since gilts benefit from safe-haven flows if the economic environment in Europe deteriorates.”
Equities: opportunities on back of rising dollar
US equities will thrive on the back of an upward US dollar, sustainable growth, low interest rates and generous share buybacks in 2015, industry figures believe.
UBP chief investment officer Jean-Sylvain Perrig said assets related to the health-care and technology sectors should be favoured.
He said: “This is where we are seeing the best earnings revisions and great growth potential, which should translate into an increase in premiums for these sectors over the rest of the market.”
But he said the equity outlook for Europe was “less attractive” as earnings’ growth expectations were “very high” and would have to be revised downwards.
Elsewhere, JP Morgan Asset Management chief market strategist UK and Europe, Stephanie Flanders said investors should not fear a rising US dollar because it meant US earnings were likely to grow at roughly mid-single digit pace.
“A stronger dollar is a win-win situation for the global economy if it helps to sustain the US recovery and revives demand in the rest of the world,” she said.
JPMAM described the picture as “less clearcut” for emerging market equities, which remain hindered by the slowing of Chinese growth, weakness among commodity producers, political drift away from free enterprise and the potential impact of higher US interest rates.
By contrast, ING Investment Management said the potential for slower US company earnings growth and tighter monetary policy would make the equity market less US-centric. Eurozone and Japanese companies may accelerate because of easy monetary policy and positive exchange rate effects, however.
ING IM equity strategist Patrick Moonen said: “Japan is our favourite because of its very favourable valuationgrowth trade-off. US valuations are a bit expensive, although certainly not in bubble territory. More buybacks in the US would even offset lower profit growth.
“The eurozone‘s fortunes will depend on policymakers delivering, but both dividend yield and growth are available in the region. Valuations in both the eurozone and Japan will be underpinned by earnings and policy cycles.”
Volatility shocks will make alternatives attractive
Increased volatility in equity markets will create opportunities in alternative assets such as property in the coming year, Principal Global Investors says.
The asset manager’s chief global economist Bob Baur said markets were likely to anticipate a more dovish Federal Reserve and a delay in rate hikes in the year ahead, meaning investors run the risk of being taken by surprise by a bout of volatility in 2015.
However, he added: “2015 may be a year of lower investment returns than recently experienced, but there may be some opportunities for investors in alternative areas like real estate. Despite investor fears over Europe, we believe investment opportunities in 2015 will predominantly be in developed markets like Europe and the US. Emerging markets are likely to experience continued difficulties next year as excess market liquidity on which they thrive is removed.”
Meanwhile, Hermes Real Estate chief executive Chris Taylor said finding value will prove more challenging in 2015 – as levels of distress reduce and pricing becomes more stretched, or moves ahead of the fundamentals, in core markets.
He said: “We will be looking to capture the growth in strong local economies in 2015, particularly in the UK and US, with a focus on assets that can thrive in this challenging and changing environment. We will also seek to diversify our exposure through debt and residential markets in the UK, as well as other alternative asset types benefitting from structural change.”
Investec Asset Management said a rise in US rates would increase volatility, but equities should be able to ride through the subsequent “noise”.
Focus on assets that can cope with anaemic growth
Investors should avoid knee-jerk reactions to central bank announcements by seeking assets that can cope with the subdued levels of growth expected in 2015, according to Schroders.
Schroders head of multi-asset investments Johanna Kyrklund warned in the absence of a more vigorous global economic recovery, it was difficult to rotate into the cheaper assets which tend to be more cyclical.
This, she said, explained why investors remain stuck in a loop, “endlessly chasing yield and pushing already expensive assets to even loftier levels”.
She added: “Where previously we had emphasised ‘making hay while the sun shines’, we are now focused on avoiding potholes. Rather than relying on knee-jerk responses to central bank announcements, we prefer to focus on assets which can cope with anaemic economic growth.
“This leads to us to avoid credit- related asset classes due to expensive valuations and potential illiquidity. Yes, yields could keep on grinding lower but it feels increasingly speculative at this point.”
Bah, humbug! The folly of forecasting
David Lloyd, head of institutional public debt at M&G Investments, believes crystal ball-gazing is a fool’s errand.
From predictions of economic growth to a view of future gilt yields, institutional investors are conditioned to follow forecasts and invest in the expectation of outperformance. Forecasting the future is a widespread activity among credit investors seeking an extra edge, particularly in fully-valued fixed income markets. But the problem with forecasts is that they are an absurd notion. The global financial and economic system is bewilderingly complex; no amount of crystal ball-gazing can generate consistently accurate assessments of what will come to pass 12 months from now. For example, in December 2013 economists’ consensus forecast for 10-year gilt yields at the end of 2014 was of 3.2%. For the following 11 months, 10-year gilt yields averaged 2.6%, dipping below 2% in October.
One might think central banks would be a good source of reliable forecasts, yet they are not, in fact, very good. Nor should they be, I would argue. This is absolutely not a criticism; I merely contend that it can’t be done. It appears that central banks are themselves facing up to this. The Fed and The Bank of England both now talk to about ‘trigger levels’ for policy response; to me, this is a tacit admission they will no longer rely primarily on forecasts in order to set monetary policy.
If the most scrutinised forecasters, with access to the widest and deepest range of information, struggle to predict the future, then what is really important for investors to consider? The answer is value, and the critical question in searching for it is: where is risk adequately rewarded, and where is it not? So, for credit investors, there are really two follies of forecasting: one, that it can be done and two, that it is needed.
For investors who eagerly await the plethora of investment outlooks for 2015, remember forecasters not only need to get it right once, but to repeat their successful forecasts year after year. As Niels Bohr, Danish physicist and Nobel Peace Prize winner, surmises so succinctly: “Prediction is very difficult… especially if it’s about the future.”
This is an edited version of an article available in full here.
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