Mercer’s 2006 forecast strong, but not stellar

By Kate McCaffery | January 9, 2006 | Last updated on January 9, 2006
3 min read

The combined wisdom of investment managers from 157 firms worldwide, suggests that global equity performance will be positive in 2006, but will almost certainly lag 2005 returns.

In the 15th annual “fearless forecast” produced by Mercer Investment Consulting, money managers say they expect equity performance in 2006 will trail last year’s double digit returns for most major global indices. Many are predicting a particularly sharp decline in their outlook for emerging markets.

Corporate profits and interest rates are the two dominant issues managers say will likely affect capital markets in 2006. “Oil prices are also expected to play a role in every country’s capital markets,” say the study’s authors.

In their asset allocation strategies, managers say public and private equities will be the top two performing asset classes in 2006. Australian and European managers favour hedge funds while their U.K. and Singapore counterparts prefer real estate investments. Long bonds and credit are the least-favoured asset classes globally.

Nearly 53% of Canadian managers agree publicly-traded equities will be among the top performing asset classes in ’06, followed by private equities and commodities. Non-investment grade debt and real estate are widely predicted to be among the weakest performers.

Half of those surveyed say Canadian markets will be more volatile this year compared to 2005, while 42% say volatility will remain the same, and 8% say the market will be less volatile.

When asked for their global and regional views on the economy and capital markets, respondents said global equity markets will likely achieve a median 7.6% return in 2006. This is down from the 9.5% return for the MSCI World Index, reported in 2005. They put predictions for the Europe, Australia and Far East (EAFE) Index, around 8% on average, compared to the 13.5% return posted in 2005. Although there was a wide variation among predictions for the EAFE Index, manager in all regions say they expect more volatility in equity markets in 2006 compared to 2005, particularly outside of the United States.

For the third consecutive year, managers say Japan has the most attractive equity markets, but performance expectations are only marginally higher than other regions. The median prediction for the MSCI Japan Index is 9% in 2006. Markets in Brazil, Germany, United States, China and Hong Kong and South Korea are also expected to perform well.

In the U.S., managers expect the MSCI USA Index to return 7.5% in 2006, up from the 5.1% reported in 2005. Emerging markets are expected to come in with returns around 9%, far below the 34% return generated by the MSCI Emerging Markets Index in 2005.

The majority of investment managers surveyed say they expect investment grade and non-investment grade bond spreads to widen in 2006. The best performing bond markets in the coming year are expected to be in Australia, the U.S., Britain and New Zealand.

Mercer says in nearly every region, the majority of investment managers expect pension funds will increase their allocation to alternative investments like private equities, hedge funds and commodity and currency overlays, generally by less than 5%, except in the U.S. where nearly 60% of investment managers expect those allocations to increase by 5% to 15% or more.

Alternative asset classes that are expected to enjoy the largest allocation increases are private equities, hedge fund-of-funds in ever region except Canada, single manager hedge funds in Australia and the U.S., real estate in Singapore and the U.K., commodities in Europe and the U.S., and infrastructure and currency overlays in Canada.

Interestingly enough, Mercer says “a significant proportion of investment manager respondents in every region expect a rise over the next three years in client demand for integrating environmental, social and corporate governance issues with investment decision making.” European managers expect the most client support for social, corporate and environmental accountability, while U.S. managers anticipate the least.

In general economic news, managers predict global real GDP will increase by 3.1%. Regionally, managers expect the highest GDP growth in Singapore with median forecasts around 5%, followed by median forecasts of 3.5% for the U.S., 3.3% for Australia and real GDP forecasts coming in at 3% for Canada. Slower growth is expected in the U.K. and Europe, with median real GDP forecasts of 2.1% and 1.9% respectively. Managers say inflation will remain relatively benign in 2006. The U.S. and Australia have the highest average rates of inflation forecasted – around 3%, while Singapore has the lowest predicted rate of inflation of 1.6%.

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Kate McCaffery