Why uncertainty will typify markets this year
Last year was a good one for many pension funds, with markets producing decent returns at low-ish levels of volatility.
The FTSE 100 rose, for example, 14 per cent, while the index’s volatility fell by 6 points.
As 2014 kicks off, volatility remains low: the VIX is at the bottom of its range, credit spreads continue to tighten and economic forecasts have been upgraded across the globe.
Perhaps overoptimism is, in fact, our greatest risk
However, investors crave certainty, and the outlook is anything but. Newcomers like Mark Carney and Janet Yellen take up their new roles as master puppeteers, and though the feeling is generally positive about macroeconomic recovery, the exact roadmap – or the 'how' – remains uncertain.
Which factors will indicate true and lasting economic recovery is also unclear.
Ben Bernanke left his post last year after having made the significant statement that the Fed intended to reduce, or taper, its asset purchasing programme.
Equity markets had always dropped in reaction to this word, but that time, they rallied; somewhat surprisingly, tapering has proved a non-event.
Markets today, and the social and economic factors that drive them, are more complex than ever before, and newcomers like Carney and Yellen face them with no history book to consult for guidance.
Financial products are keeping pace in their complexity too. Collateralised loan obligations, which were blamed partly for the financial crisis, are again becoming popular as credit spreads remain at the tight end of their range.
Ambiguity seems to be the word of the year for 2014. Whether equities will continue to rally remains unclear, especially because the reason for the rally remains opaque; whether rates will rise is up for debate, and so is the future path for tightening credit spreads.
Markets at the start of 2014 are so far calm. But all that could change. Perhaps overoptimism is, in fact, our greatest risk.
For pension funds and investors, in this uncertain world, there is only one reasonable path.
That is to work diligently and continuously to establish an investment strategy that is resilient to many outcomes, not just the frequently changing current forecasts.
First and foremost must be the avoidance of loss, the quest for return secondary. All markets can be measured by risk so the biggest danger is a sharp rise or change in risk that investors are not expecting.
The most important new year resolution must then be, bearing in mind the inherent uncertainty in the world around us, seeking return in a sustainable way.
That is, maintaining an investment strategy that is robust to unexpected market events, resilient to the unknown unknowns.
Rob Gardner is co-founder and co-CEO at consultancy Redington