When it comes to financial markets, instincts often turn out to be wrong.
It’s that time of year when many organisations and publications conduct surveys of investment professionals and market participants to attempt to elicit a consensus on themes and views for the year ahead. Such surveys are always fraught with difficulty, and generally destined to be proven wrong with hindsight. Financial markets have a habit of producing unexpected outcomes.
However, this one is a little different. Rather than trying to assess asset returns, we decided to approach the situation from a risk perspective.
During early January we did an anonymous survey where participants submitted expectations for market volatility in the coming year. Many of the responses were based on nothing more than instinct or “gut-feel” over a morning coffee. We fully expect these to be proved wrong in hindsight of course, and we stress they do not constitute a house view neither do they affect our assumptions on which we base our advice. As much as anything they illustrate the shortcomings of such gut-feel surveys, as on the face of it some answers seem surprising. We don’t feel that our instincts are likely to be better than anyone else’s – which is why we adopt a rigorous approach to determining our investment assumptions. Nevertheless it is interesting to view the results, and it leads to an interesting debate on whether the coming year is likely to be more or less volatile than previous, clearly it is hard to say with any certainty whether that is true or not. More than anything it emphasises the need to have a clear framework for managing risk.
Unless otherwise stated all volatilities are interpreted as the annualized standard deviation of daily log price index returns, in local currency. For swap rates we answered in terms of a basis point volatility of yields.
Now have your say
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Redington Instincts Risk Survey 2013 Results
Overall, the average survey results were for higher volatility across asset markets next year compared to recent history, particularly commodities and credit. For example the survey gave:
• An average expectation of 22% for Commodity volatility compared to 13% in 2012 and 14% over the last 2 two years
• An average expectation of 10% volatility for Investment Grade Credit vs 5% in 2012
• An average expectation of 17% volatility for High Yield Credit compared to 4% in 2012
Other observations in asset volatilities included:
• An expectation that Emerging Market Equity would be the most volatile asset class, whereas property the least. However, Commodities come in as a close second to be the most volatile asset class, winning 43% of votes compared to 50% votes for Emerging Market equity
• Across all asset classes, the survey expectations were for higher volatility than in 2012. Survey expectations were more in line with the medium to long term volatilities (since 2006), take equity for example:
• Developed Market Equities survey expectation volatility of 19% with a quarter of the firm seeing a result above 20%. (long term volatility 20%)
• Emerging Market Equities survey expectation volatility of 23% with a quarter of the firm seeing a result above 25%. (long term volatility 24%)
• Historically, 2012 saw lower volatility across all asset classes compared to either 2011 or the previous seven years
• Interestingly, Redington’s collective expectation of risk associated with European High Yield Credit is higher than the historical volatility, either on a short term or on a long term basis.
• The average survey expectation for the largest intra-year drawdown in developed equity markets during the coming year was -20% something we haven’t seen since 2008
• The average expected intra-year drawdown in High Yield Credit was also quite severe at -18%, much higher than has been experienced in the recent past
For liabilities, the survey expectation was for similar level of volatilities in real yield this year compared to last year:
• Average survey expectation of the 20 year UK swap of 60 bps (vs. 69 realised in 2012)
• Average survey expectation of the 20 yr UK inflation volatility of 43 bps (vs. 37 realised in 2012) Note: the survey was carried out prior to last Thursday’s CPAC announcement