2014: A Low-Return and High-Volatility World

Russell Investments on opportunities in an “uncomfortable reality” of 2014.

(February 18, 2014) —Remember the equity market rallies of 2013? Investors would be best served to keep them as memories, as 2014 has a very different time in store for non-profit investors, Russel Investments has warned.

Moderate economic growth and returns will require investors to be increasingly aware of upside and downside risks, all the while they should monitor rising volatility in 2014, the consultants said.

Winding down from one of the best years in a decade, the global equities market stands at a fork in the road—one towards a “speculative overdrive” or another towards a loss of much of its 2013 gains due to disappointing economic growth.

So early in the year it is difficult to foretell which is more likely, so investors should expect lower returns and higher volatility than last year.

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“The uncomfortable reality is that global bond yields have further to rise, credit spreads have little room to narrow, and equity markets are trading at fairly full valuations along a variety of different metrics,” said Jeff Hussey, Russell’s global CIO.

A report from the firm said equity market returns were expected to be “mid-to-slightly-higher single-digit” in a rising rate environment and small cap equities’ outperformance would slow down. US large cap equities could anticipate a gain of 4% to 5% with a dividend yield near 1.7%.

Expected volatility and lower returns mean downside risk protection and active management may be good recommendations for the coming year.

Government bonds are also expected to produce moderate returns, due to the US Federal Reserve’s moves towards tapering in the first half of 2014.

“Continued accommodative monetary policy combined with low inflation will keep rates low,” Russell said. “That said, the onset of tapering in quantitative easing is likely to cause some volatility and could provide a tactical buying opportunity.”

However, with high quality sovereign bond returns predicted to remain in the low single digits, appetite for real assets is expected to increase “as bond investors seek other sources for yield.” Listed infrastructure and real estate, in particular, would benefit from economic growth while commodities are likely to be “held back” due to new supplies of energy and lower demand from China.

“The challenge for investors in the coming low return world is to achieve their required rate of return at a level of risk they can survive,” Hussey said. “The best way to do this, in our opinion, is through the use of actively managed, globally diversified multi-asset strategies. Set it and forget it won’t cut it anymore. In a low-return world, every basis point counts.”

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PIMCO Explains New Deputy-CIO Structure—and Its Bond Optimism

Founder Bill Gross writes of a new and improved PIMCO and a positive outlook for 2014’s bond market.

(February 18, 2014) — PIMCO’s founder Bill Gross has aimed to reassure clients of the firm’s stability and new leadership structure after CEO and co-CIO Mohamed El-Erian announced his resignation last month..

In a letter to clients, Gross said he remained confident that the new governance organization—inclusive of six deputy CIOs—would be “a significant improvement.”

The senior leaders—Dan Ivascyn, Andrew Balls, Mark Kiesel, Virginie Maisonneuve, Scott Mather, and Mihir Worah—would each lead an “individual ‘channel’ of assets,” managing investment performance, strategies, and risk management in their areas of expertise. They were appointed to their roles after El-Erian’s resignation.

“The basic idea is that the deputy CIOs will apply the views of the investment committee and tailor them to their respective areas,” Gross wrote. “We will take turns chairing our daily meetings, which will allow for greater focus on certain sectors and regions.”

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Gross said while the new structure was not fundamentally different from one that had been in place before, it would help increase “nimbleness within [the deputy CIOs’] channels” to bring better long-term returns to clients.

“These are experienced investors on the front lines of strategy and the pursuit of alpha, and their contributions can only deepen our understanding of the economy and markets and improve portfolio construction across PIMCO,” he added.

According to the firm’s reports, the Total Return Fund saw nine consecutive months of outflows—a total of $41.1 billion—and recorded a negative return for the first time in 14 years last year. 2014 was similarly unkind to the bond giant, with another $3.5 billion pulled out and a low gain of 1.35% in January.

Some investors are wary of the changes. The Orange County Employees Retirement System has put PIMCO’s Unconstrained Bond Fund on “watch list for changes in key personnel,” according to its investment committee’s meeting agenda, posted online this month.

However, Gross remained positive and optimistic for new opportunities in the coming months.

“The outlook for the bond market is much better than in 2013,” he wrote. “Interest rates have adjusted upward and now reflect better value. We think 10-year Treasuries at 2.6% are attractive.”

Volatility will still be a concern, he added, due to high leverage in the financial system and deceleration of credit growth. PIMCO would continue to be highly selective and cautious across all asset classes, he said.

“Fortunately, PIMCO has a structure and process firmly in place to help clients navigate and hopefully prosper from it,” he said. “We believe this new format, and the idea sharing it will facilitate, will be more responsive to market developments. It will be great!” 

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