Despite a grim economic outlook, institutional investors are positive about the markets, believing most asset classes hold the potential to deliver positive returns. But few expect to make major portfolio changes this year.
Institutional investors optimistic in the face of a tougher year ahead
The outlook for the global economy appears bleak, with the International Monetary Fund (IMF) warning that 2023 will be ‘tougher’ than last year as the US, EU and Chinese economies slow. Indeed, the head of the IMF, Kristalina Georgieva, has warned that a third of the world economy will be in recession – and even in countries that are not in recession; it will feel like recession for hundreds of millions of people. The war in Ukraine, rising prices, higher interest rates and the spread of Covid-19 in China are all weighing on the global economy.1
Annus horribilis for investors
Moreover, 2022 was one of the worst years for global investors since the 2008 financial crisis. The yield on 10-year Treasuries rose by the most since the 1960s, leaving many fixed-income investors nursing losses. Meanwhile, global equities, as measured by the MSCI All-World index of developed and emerging-market equities, lost a fifth of its value this year, the biggest drop since 2008, with most major markets registering significant declines.
Yet despite this background, many institutional investors are optimistic. Over three-quarters of the 500 allocators surveyed by Natixis, for example, said they would either maintain or raise their current average return assumption of 7.9%. Considering the prospects for elevated volatility, high inflation, rising rates, slow growth and a likely recession, institutional investors were remarkably optimistic for most asset classes. Firms focused on fixed-income strategies were especially optimistic, with 46% of insurers planning to increase their projections from an average of 6.7%. Many allocators believe that bonds hold the potential to outperform in 2023, following a dire 2022.2
Institutions also hold a bullish view on private equity, with Natixis believing they may be counting on private equity to compensate for lacklustre equity returns in public markets.
Fixed income – the comeback kid
Interest rates fell to remarkably low levels after the global financial crisis, as central banks stepped in to prevent the world enduring a repeat of the Great Depression. They declined even further as central bankers attempted to shield populations from the fallout of the Covid-19 pandemic. But many investors are bullish on bond-market performance in 2023, presumably anticipating that, as inflation peaks, central banks may begin to cut interest rates in the latter half of the year, enhancing the appeal of fixed income.
Figure 1: Interest rates to remain higher for longer
Equities – value reappears?
Despite – or perhaps because of – a year of significant losses in 2022, and expectations for continued volatility, a surprising number of institutions (51%) say they’re bullish on stocks in 2023. Certainly, equity markets have a record of rebounding well before the economy starts to pick up, and with so much gloom priced in during 2022, markets could well bounce back as soon as any chinks of light in terms of the economy or corporate earnings become apparent.
Real estate
Investors usually look to property as a shield against inflation, but the real-estate market has been complicated by Covid-19 pandemic-related shifts in working and living that have added to the challenges facing investors. Perhaps unsurprisingly, as a result, 82% of investors have a bearish view of the asset class – although some are looking for highly targeted investments.
The return of inflation and rising interest rates provide investors with a completely different set of challenges from those they have faced for the past 15 years and more, yet few anticipate significant changes in allocation strategy. In fact, the Natixis survey found that, on average, institutional allocations will shift no more than 1% in any given asset class. However, while little is planned in the way of large allocation shifts, many anticipate significant adjustments within asset classes to position portfolios for the year ahead.
1 https://www.bbc.com/news/business-64142662
2 https://www.ft.com/content/87ed8ea6-4913-4452-9135-498040ad338f
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