State Street’s monthly Investor Confidence Index for July fell by 7.7 points globally from June, driven primarily by a drop in the European index following recent turmoil in the region.
Investors tend to sell out of regions where economic or political upheaval is underway, as evidenced by last year's August scare.
If there is general business confidence, then there will also be trustee confidence
Colin Richardson, PTL
This summer, investors are again seeking shelter. Events such as Brexit and Turkey’s failed coup were the major geopolitical events that disturbed European investors in particular, leading to a decrease in risk appetite demonstrated by lower equity allocations and other risky asset classes.
The Global ICI decreased by 7.7 points from June’s 105.7 to 98 in July, State Street, the financial services provider, found. It said that the drop in investor confidence was provoked largely by a fall in the European ICI from 100.3 in June to 92.4 this month.
State Street said the Brexit and Turkey events compounded existing anxiety about low “global growth prospects”.
The index, in which a 100 reading is neutral, quantitatively measures investors' risk appetite or confidence by analysing their actual buying and selling activity, and interprets higher equity allocation as an indicator of higher confidence.
State Street said that “globalisation has come under heavy political pressure”. European institutional investors will now have to think harder than ever about how to maintain returns in an environment that inspires risk aversion.
Sentiment unlikely to deteriorate further
Tim Graf, head of macro strategy for Europe at State Street, said of the ICI’s July drop: “The dialogue around Brexit has driven a lot of this action.” While he said that sentiment is unlikely to deteriorate much further, neither is it likely to rebound completely as the post-referendum chaos dies down.
This is especially true at corporate level, he said, adding that “uncertainty has to be worked off” before confidence can climb again. “Raising of spending ratios at the corporate level is a by-product of confidence.”
Graf said “the onus now is on fiscal authorities” to improve investor confidence, but “policymakers are never truly out of actions” either.
A relaxation of austerity might also help, he added, but ultimately “it might take another crisis of confidence for governments to take action”.
However, Graf stressed that a repeat of the 2011 eurozone crisis is unlikely. “Now there is more fiscal pragmatism where it didn’t exist before,” he said, adding that governments are devoting more attention to resuscitating investor sentiment.
No need for short-term changes
Colin Richardson, independent trustee and client director at PTL, said that he had not observed a sharp drop in equity allocations among UK pension schemes since the Brexit vote. While trustees have been discussing whether reaction is needed, it is generally agreed that short-term changes are not necessary, he said.
This is because most pension schemes saw “minimal impact” from the vote, as the majority were well-hedged. Richardson added that most schemes still have high equity content as a result, although he conceded that equity allocations have been gradually falling for a while.
Richardson said that low risk appetite can prove particularly risky for those schemes that are not fully funded, because it means a scheme will have to rely on a potentially weaker sponsor.
He added that there is not much that policymakers can do to improve risk appetite among pension schemes. A possibility would be “a loosening of funding legislation”, allowing for longer recovery periods, but he said this is a “dangerous” solution and therefore “it is hard to see this happening”.
Realistically, he said, political turmoil around events including Brexit will simply have to be waited out, as little can be accurately predicted.
“If there is general business confidence, then there will also be trustee confidence,” he added, noting that much depends on how pension schemes feel about their sponsor covenant.
“It is a challenging time," said Richardson. He said that trustees should bring consideration of medium and long-term strategy forward for discussion sooner than they might have planned.
Andy Green, chief investment officer at consultancy Hymans Robertson, said the fall in the index continues a trend started in March this year.
"Over the first six months of 2016, as confidence in GDP growth wanes, yields on core government bonds have fallen. With global equity markets flat over the same period, institutional investors will have felt a shift in asset allocation away from risk assets simply due to the rise in value of bond holdings, when equities stood still," he said.
He said this is exacerbated in the UK, where pension funds tend to hold longer durations than elsewhere, and saw high returns due to the larger fall in gilt yields after the EU referendum outcome.
Green said he did not expect pension schemes to move back into equities soon. "Instead it may be a case of targeting more income-based assets, where the returns are at least more predictable and the path to recovery is more resilient."
