Institutions Show Positive Outlook for 2014

The expectations of institutional investors are predicted to remain positive during 2014 and beyond, says a new survey.

The Commonfund Investor Outlook Survey gauged the sentiments of more than 200 respondents, representing a broad range of nonprofit institutional investors and pension funds with combined assets of $163 billion.

Overall, investor expectations for 2014 are reasonably strong with an average forecast for the S&P 500 Index of 6.5% and a median forecast of 7%. This represents a slight decrease from last year’s average forecast of 7.9% and a median forecast of 8%.

The dispersion of expected annual performance narrowed with 60% of respondents expecting a return of between 5% and 8%. Over a three-year period, performance expectations were slightly lower with an average annual forecast for the S&P 500 Index over the next three years of 6.25%, compared with last year’s 7.1%.

“The data indicates a level of realistic optimism that’s both refreshing and important,” says Verne Sedlacek, president and CEO of Commonfund in Wilton, Connecticut. “Additionally, despite recent discussions surrounding emerging markets, we were pleased to see that investors have a positive viewpoint towards it, in addition to other long-term strategies.”

Investors report overall expectations for annual performance of institutional portfolios as follows:

  • Average 7.3% and a median 7% returns for one year vs. an average 7.6% and a median 7% last year;
  • Average 7.5% and a median 7% returns over three years vs. 7.3% and a median 7% last year; and
  • Average 7.7% and a median 8% returns over five years vs. 7.4% and a median 7% last year.

Survey respondents were asked about tail risks over the next three years. Tail risks are a form of portfolio risk that arises when the possibility that an investment will move more than three standard deviations from the mean is greater than what is shown by a normal distribution. Forty-four percent of respondents say that tail risks are increasing vs. 38% reporting the same last year. On the other hand, 11% on institutional investors say tail risks are decreasing vs. 13% last year, and 45% say they are staying the same vs. 49% last year.

The most significant tail risks reported relative to portfolio performance over the next three years have shifted greatly from a national concern to predominantly international concern. Fifty-eight percent of respondents cited geopolitical crisis as the most significant tail risk. The gridlock in Washington, the number one concern last year, decreased from 62% to 37% this year. Turmoil in the Mideast increased to 55% vs. 46% last year, and a slowdown in China increased from 26% to 46%.

In terms of market and index performance, the survey finds that emerging markets show a tempered level of confidence among investors with 58% of respondents expecting the MSCI Emerging Markets Index to outperform the S&P 500 Index over the next three years, compared with 78% last year. In a big increase from last year, 42% expect the MSCI – ex US (developed equity markets) to outperform, vs. 23% last year.

Twenty-six percent of respondents expect commodities, as measured by the Dow Jones-UBS Commodities Index, to outperform the S&P 500 Index over the next three years, compared with 27% last year. And 29% of respondents expect hedge funds as measured by the HFRI Fund Weighted Composite to outperform, compared with 26% last year.

Sentiment towards bonds had a slight upward shift with 5% of respondents expecting the Barclay’s Aggregate Bond Index to outperform the S&P 500 Index over the next three years, compared with 3% last year. Eight percent of respondents expect high yield bonds as measured by the Merrill Lunch High Yield Bond Index to outperform vs. 7% last year.

With regard to U.S. Treasury yields, the survey finds that expectations for the yield on the 10-year U.S. Treasury note by year-end 2014 reflect a modest increase in interest rates from current levels. With the 10-year U.S. Treasury at 2.8% as of early March 2014, the average and medium expectation from survey respondents see the figure at 3% over the rest of the year.

Approximately 19% expect little change or a slight decline, while more than one-third expect yields to rise to the range of 3.25% to 3.50%. Last year respondents expected the average yield of the 10-year Treasury to be 2.1% by year-end 2013.

As for asset allocations, 13% of respondents indicated they expect to decrease allocations over the next 12 to 18 months in their emerging markets equities compared to only 3% last year. Forty-two percent of respondents expect to increase allocations compared to 55% last year. European equities realized the biggest jump in expected allocations with an increase from 18% in 2013 to 29% this year.

The survey finds that the two greatest areas of concern for institutional investors are market/investment volatility and shortfalls in meeting return objectives. Although down slightly from 56% last year, market volatility was acknowledged as a concern by 54% of respondents this year. Shortfalls in meeting investment return objectives ranked second again this year, but dipped slightly to 42% from 48% last year. Other areas of concern include portfolio liquidity (66% vs. 62% last year) and deflation (64% vs. 76% last year).

The survey also asked respondents whether or not clients are planning to increase their use of fund-of-funds vehicles in their investment strategies. One in four respondents expects to increase their use of private capital fund-of-funds. For both hedge funds and private capital, more than half do not expect a change.

Commonfund is an organization that works to enhance the financial resources of long-term investors including nonprofit institutions, corporate pension plans and family offices through fund management, investment advice and treasury operations.

More information about the survey results can be found here.