No. 1 Worry for European Investors: Interest-Rate Risk

(June 16, 2011) — European institutional investors view interest rate risk as a top concern, a new study by Allianz Global Investors shows.

Among pension funds and other institutional investors in Europe, government credit risk ranks as the second-biggest threat to investments. Of the 156 respondents surveyed, about 47% of respondents cite government credit risk as a considerable risk and about 15% as a huge risk.

Perception of risk varies by location, the study shows. Investors in Austria, France and Italy are most concerned about sovereign debt risk largely as a result of bailout packages granted to Greece, Ireland and Portugal. Meanwhile, British and Scandanavian investors view declines in market prices as well as interest rates as the main risks.

In the next 12 months, hedging interest rate exposure, monitoring risk and further diversification are the three most popular options to deal with risk, the study shows.

The perceived threat of inflation among European investors echos findings from a Mercer survey last month that showed European pension funds are buying inflation-protected instruments to guard their portfolios from increasing inflation. The investment consultancy’s annual European Asset Allocation Survey of more than 1,000 European pension funds with assets of over $812 billion found that compared to last year, an overwhelming 80% of respondents are now more concerned about the threat of rising inflation.

“Protection, through acquiring inflation hedging assets (such as inflation bonds and swaps), looks to be expensive and there is a risk that such investments provide ‘insurance’ for events that never actually happen,” Tom Geraghty, Mercer’s head of investment consulting for Europe, Middle East and Africa, commented in a statement. “Pension funds also need to understand the extent to which their liabilities are affected by higher inflation. In some cases, inflation caps may mean that higher inflation is less negative for pension schemes than might be expected,” he said, noting that it is imperative that schemes understand how their liabilities are impacted by various inflation scenarios.