Based on their outlook, respondents expect to increase allocations over the next 12 to 18 months most significantly in emerging-market equities, natural resources, commodities (similar to last year’s results), as well as venture capital, private equity and real estate. Unlike last year, this year the largest decreases were forecast for U.S. Treasuries; European equities and cash. Other decreases include core U.S. fixed income and Japanese equities.
Fifty-three percent of respondents said they would increase allocations to emerging-market equities, up from 40% last year; while only 1% said they would decrease allocations this year. Similarly, 44% cited that they would increase allocations to natural resources, up slightly from 43% last year. Forty percent would increase allocations to venture capital and private equity, up from 32% last year. Thirty-seven percent said they would increase allocations to real estate, up from 27% last year. Thirty-four percent said they would increase allocations to commodities, down slightly from 37% last year. Thirty-one percent said they would increase allocations to distressed debt/high yield, up significantly from 18% last year. Twenty-eight percent said would increase allocations to hedge funds, up slightly from 27% last year. Six percent said they would increase fixed-income allocations, up from 3% last year.
Overall, investor expectations for 2012 are reasonably strong with an average forecast for the S&P 500 Index of 8.3% and a median forecast of 9%. This was almost unchanged from last year’s average forecast of 8.55% and median forecast of 9%. Over a three-year period, performance expectations are still strong with an average annual forecast for the S&P 500 Index over the next three years of 6.8%, and 72% of responses in the range of 5 to 8%. This was slightly lower than last year’s average forecast of 7.3% and median forecast of 7.5%.
“The positive expectations for the markets and asset allocations indicate that participants continue to be positive about 2012, reflecting the continued improvement in the U.S. and much of the world economies,” said Verne Sedlacek, president and CEO of Commonfund. “Increased allocations to emerging-market equities, natural resources and commodities extend last year’s strong outlook and the recovery from 2008 to 2010.”
Only 44% expect commodities (as measured by the Dow Jones – UBS Commodities Index) to outperform the S&P 500 Index, compared with 61% last year. Thirty percent expect hedge funds (as measured by the HFRI Fund Weighted Composite) to outperform, similar to last year.
Only 37% expect high yield bonds to lag the S&P 500 Index compared with 49% last year. Eighty-four percent expect the Barclay’s Aggregate Bond Index to underperform the S&P Index over the next three years vs. 91% last year (only 3% expect it to outperform this year vs. 4% last year). Relative to the three-year performance expectation for the S&P 500 Index, 75% of respondents expect the MSCI Emerging Markets Index to outperform, a slight drop from 79% last year. Twenty-two percent expect the MSCI – ex U.S. (developed equity markets) to outperform this year.
U.S. Treasury Returns to Drop
Survey participants’ expectations for the yield on the 10-year U.S. Treasury note by year-end 2012 were as follows: 33% responded between 1.50% and 2%; 49% responded between 2% and 2.50%. Average expectations were 2.2% and a median 2.25%. This contrasts with last year, when 60% of respondents saw interest rates rising in 2011 and one-in-four expecting rates, as measured by the 10-year U.S. Treasury Note, to rise above 4% by December 2011 (versus 3.41% as of February month-end).
Portfolio Performance and Tail Risks
In a new question this year, participants reported overall expectations for annual performance of institutional portfolios over the next one, three and five years: an average 7.4% and a median 8% for one year; an average 7.2% and a median 7% over three years; and an average 7.6% and a median 7% over five years. Another new question asked participants about tail risks over the next three years. Forty-six percent said tail risks are increasing, 9% said they are decreasing and 45% said they are staying the same.
The most significant tail risks participants reported relative to portfolio performance over the next three years include: EU Crisis (32%); Washington gridlock on U.S. debt (23%); oil price jump (16%); U.S. recession (4%); China slowdown (2%); and other (24%).
Areas of Greatest Concern
Like last year, Commonfund asked participants to rate 11 different factors and asked them to rate their concern about these factors, relative to the management of their assets. Respondents answered along a five-point scale with “1” being “no concern”; “3” being “modest concern” and “5” being “extreme concern.” The top three areas of great concern (based on respondents rating factors as a “4” or a “5”) are:
- Market (investment) volatility: 69%, up from 55% last year;
- Shortfalls in meeting investment return objectives: 63%, up from 54% last year; and
- Risk management (broadly defined): 38%, down from 45% last year.
In contrast, the factors of least concern to respondents this year (rating of a “1” or a “2) were:
- Deflation: 64%;
- Portfolio liquidity: 50%;
- Costs of investment management: 39%, down from 43% last year;
- Structure/effectiveness of investment resources (staff and board): 39%, down from 42% last year; and
- Inflation concerns were 28% this year, down from 53% last year.