It’s the central bank, stupid. Five years after the US Federal Reserve Bank started its first round of quantitative easing, investors agree that much of the risk in capital markets stems from
monetary policy. Of all the respondents to the , a survey among senior decision makers at institutional investors, 55% said that the asset-buying programs of central banks increased the risks borne by investors. The creation of asset bubbles and market distortions was another effect often cited by respondents. Global RiskMonitor: Prepare for landing
While this is hardly surprising, an astonishing 28% of the same group said that their institutions had not changed their investment decision-making process since the financial crisis. The risk has been discovered, but it is ignored by a significant share of money managers.
HOUSE OF CARDS
Central bank action is believed to create risk particularly in the long run. More than half the respondents fear that the current policy increases inflation (57%).
About this report …
The Global RiskMonitor, published annually by Allianz Global Investors, collected responses from 390 business professionals during the summer of 2013. The respondents hold positions such as chief investment officer, chief operating officer, director of research, CEO/managing director and portfolio manager in large financial firms. The current study seeks to understand how current monetary policy could contribute to market bubbles in the coming years, the risks posed to performance by various macroeconomic factors and the effect of regulatory developments on institutions and their decision making. Almost as many are worried about its effect on systemic risk (55%), with 54% concerned that current low interest rates damage the health of retirement savings (multiple answers possible). Said one investor, “Fed and company have yet again built another house of cards.”
Despite these challenges, investors have come to appreciate the role of central banks in providing stabilizing measures in the short term. The survey points to greater appreciation and new respect for the work of central bankers. Neither is there an easy way out of the dilemma central banks, the Fed in particular, create. In fact, there is a sense of inevitability among investors. As one director of risk management said, “Even if some investor has a correct view and goes short in the mini-bubble, they might get crushed because the timing of the inevitable-and-yet-pending correction is uncertain.”
While investors across the board expect interest rates to pick up again, this is unlikely to happen anytime soon. Less than a third of respondents expect rates to return to their long term historical average before the end of 2014. The majority is split between expecting a return to normalcy in 2015 (30%) and later (42%).
In contrast to other regions, Europeans are prepared for a longer wait. More than half of respondents (56%) don’t expect a rise before 2016, whereas only a third of US and Asian investors holds that view. Most of them expect the rate hike before that. Consequently, asset prices in the bond as well as the equity markets could be distorted, as they are primarily driven by central bank policy rather than the macroeconomic reality of the papers’ issuer.
A WAY OUT
“Increasingly, institutional investors are recognizing the long-term risk of short-term safety,” says Allianz Global Investors CEO Elizabeth Corley. In contrast to concerns about fixed income, investors’ attitudes towards equity risk are somewhat more benign. For 60% of the respondents, equity risk is seen as likely to pay off over the next three years (credit risk was mentioned by only 32%).
More than 90% expect global equities to generate positive returns over the next three years, with the average expected annual return reaching 6%. “
Investors are rightly seeking real returns. Taking no risk in this environment is not an option,” says Corley. However, asset managers’ business success will primarily depend on their ability to help clients make good use of additional risk in capital markets.
With the current degree of central bank interference in markets, some investors see regulation as a source of growing costs and increasing complexity, reducing annual returns by an average of 2.3%. “Compliance with burgeoning regulation and governance requirements places increasing burdens and costs on investment businesses,” stated one chief investment officer.
Overall, investors identify stricter regulation and capital controls from national government as the most common and acute risks to their ability to meet investment targets. A majority of respondents even expects the regulatory environment to become more stringent. The can of worms central banks have opened five years ago is unlikely to be closed anytime soon.
Allianz Global Investors RiskMonitor