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Investment managers foresee higher volatility, says Northern Trust survey


Investment managers overwhelmingly expect market volatility to increase in the first half of 2015 and remain concerned about geopolitical risk and a slowdown in Europe. 

But those issues do not alter a generally positive view of US economic and corporate profit growth, according to a quarterly survey conducted by Northern Trust Asset Management.

Eight in 10 managers said they expect volatility, as measured by the Chicago Board of Options Exchange Volatility Index (VIX), to increase over the next six months. The fourth quarter 2014 survey, taken December 3-18, set a new high for volatility expectations since the survey’s launch in October 2008, surpassing the previous high of 70 per cent in the third quarter 2014 survey.

The impact of falling oil prices and the strengthening US dollar, as well as increased allocations to index and “smart beta” strategies over fundamental active equity investments, were also topics of the fourth quarter 2014 survey.

“Managers expect volatility to increase due to geopolitical instability, economic slowdowns in Europe and Japan, US equity valuations and a dramatic drop in oil prices,” says Christopher Vella, Chief Investment Officer for Multi-Manager Solutions at Northern Trust. “Although managers foresee a difficult market, they also expect US economic fundamentals to hold up and are still bullish on US large cap equities."

A European economic slowdown moved up to second place in the managers’ ranking of risks to equity markets, and more than half (55 percent) of respondents expect the eurozone’s gross domestic product (GDP) will remain flat to negative over the next six months. Nearly all managers expect the European Central Bank to implement a quantitative easing (QE) program, and 54 per cent expect it to go into effect in the first quarter.

Investment managers’ expectations regarding the US economy remain strongly positive:
• 95% expect corporate profits to either remain the same or increase in the first quarter of 2015.
• 86% expect job growth to either remain stable or accelerate over the next six months.
• 61% expect housing prices to increase over the next six months, up from 52% the previous quarter.

A relatively large percentage of managers, 18 percent, expect that inflation will decrease over the next six months. That view is likely caused by the recent drop in oil prices, which a vast majority of respondents (86 percent) believe will have a positive effect on global GDP, while 11 per cent expect a negative impact from lower oil prices. Similarly, more than three-quarters (76 percent) of the managers believe the strengthening US dollar will have just a modest negative impact on US corporate earnings, while 19 per cent believe it will have little to no impact, or a net positive impact on US corporate earnings.

“Given the relative strength in the US economy, most managers do not expect the dramatic decline in the price of oil or the strength in the US dollar to derail the US equity market,” says Mark Meisel, Senior Investment Product Manager of the Multi-Manager Solutions group, who oversees the survey. "Most of the managers in the survey make investment decisions on fundamental analysis and they seem to remain cautiously optimistic on US equities.”

Offsetting the positive views somewhat, 36 per cent of managers said US equities are overvalued, the largest share with that view in the survey’s history. Emerging markets are seen as undervalued by 53 percent, while 49 per cent view European equities as undervalued.

On the bullish/bearish spectrum for asset classes and broad economic sectors, managers are most bullish on US large cap equities, non-US developed equities and information technology, consumer discretionary and industrials:
• Asset classes: Bullish on US large-cap equities (48%), non-US developed equities (45%) and emerging market equities (42%); bearish on US fixed income (65%) and commodities (61%)
• Sectors: Bullish on information technology (73%) and consumer discretionary (64%); bearish on utilities (69%), materials (45%) and telecom services (43%).

The fourth quarter 2014 survey also asked for views on a business issue facing active managers: the increasing asset flows and market share of passive (and smart beta) strategies. A large majority of managers (68 percent) believe that the increase in the market share of passive/smart beta strategies will not have an effect on their ability to generate excess return (alpha) over their benchmark. However 22 per cent believe the growth of these strategies will have a short-term effect on their ability to produce excess returns and 10 per cent expect a long-term, systematic impact.

And while just over half (51 per cent) of managers experienced no negative impact from the growth of passive/smart beta strategies, 46 per cent report that flows into passive/smart beta products have had a modest negative impact on their active businesses. Over the next five years, most (51 per cent) expect passive strategies to gain modestly higher market share of investment assets, while 9 per cent believe those strategies will have significantly higher market share and 41 per cent expect the same or lower market share for passive/smart beta strategies over the next five years.

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