January 28, 2011

In 2011, How to Respond to Sovereign Debt Worries, Volatility

Mercer recommends steps for institutional investors to hedge volatility, use dynamic asset allocation

Consulting firm Mercer on Friday put forth what it says are challenges and priorities that face the global investor in the “new realities” of the 2011 environment. Because advisor strategies often mirror those of institutional investors, and perhaps should more often, many of those challenges and priorities should be on advisors’ radar screens as well.

According to Mercer, 2011’s challenges make it even more necessary to take three actions:

  • focus on critical issues
  • consider investing strategies’ downsides;
  • set priorities for investment that offers robust performance in an uncertain and changing environment.

Andrew Kirton, global chief investment officer for Mercer, said that while confidence is on the rise in some Western countries, “the crisis has wreaked havoc on a number of nations’ balance sheets, has disrupted the credit allocation process in Western economies and added to the potential for global tensions.”

Differing opinions on how best to address the problems besetting the global economy have resulted in uneven approaches, with some nations choosing the path of austerity and others, including the U.S., not implementing decisive action.

Some of the “new realities” cited by Mercer are these:

  • Sovereign debt investment as a safe haven has become a questionable strategy, leading to a need to re-evaluate the wisdom of bond investing.
  • Developing economies on the rise are leading to a “two-speed” world economy. Powerful emerging nations “can call into question existing world hegemony and economic might.”
  • Rising commodity prices and the threat of inflation raise questions about the health of investment portfolios if such trends continue.
  • Financial system reform is not securely in place; therefore, a repeat of an economic crisis is still possible, with all its ensuing trauma.
  • Diversification as a deflector of risk will need re-evaluation in the face of an end to previously accepted market behavior.

Divyesh Hindocha, global director of consulting for Mercer’s investment consulting business, suggested some strategies institutional investors might want to consider as a response to these “new realities.” Investors, he said, “need to start focusing more attention on the longer term fallout and implications from the crisis and consider how to reflect this in their portfolios.” Key to this is flexibility, as well as the ability to “win by not losing.”

Hindocha added that such flexibility will allow a faster response to changing market conditions, without being tied to a single plan. “This is about being more global, having inherent hedges to control volatility, implementing dynamic asset allocation and allowing more manager discretion around benchmarks,” he said.

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