The results of the first “bfinance Fund Managers Investment Strategy and Asset Classes Consensus Forecasts” show that after overwhelmingly favouring bonds at mid-year, fund managers now expect to increase the share of equities in their tactical allocation. In addition, after a slight correction, credit spreads are generally expected to narrow in 2012. Twelve investment companies participated in the poll.

According to the first edition of the new survey, conducted by bfinance’s Studies & Research department each half-year (on 30 June and 31 December) with a panel of investment managers from among 30 of Europe’s largest investment companies, CIOs reshuffled their benchmark portfolio tactical allocation in the second half to include more equities and hedge funds. At 30 June, managers were planning to reduce the share of bonds in their portfolios over the next six months from 46% to 36% in order to increase the exposure to riskier assets. If plans were implemented accordingly, equities portfolios have grown, on average, by over six percentage points to 53.5%, with hedge funds approaching 10% of assets. At one end of the spectrum, Société Générale Asset Management (SGAM) planned to invest 60% of assets in equities while at the other, HSBC GAM put a greater focus on hedge funds (16% of the tactical allocation). Fund managers also reduced their exposure to the money market to 3%, at a time when short-term interest rates continued to hover at historically low levels.

Record amounts of corporate bond issuance at historically high spreads attracted investors towards debt during the first half of the year. Asset managers were very much present on the primary market to absorb much of this issuance. The tightening of spreads since then has encouraged greater caution, with managers now favouring equity investments.

Going forward, the composition of portfolios could continue in the same vein if a scenario of economic growth without threat of inflation takes shape in 2010. All respondents support this hypothesis and expect that the recession will end next year. For managers, growth will be more pronounced in emerging countries, followed by the United States (+1.6%), with Europe (+0.3%) just getting its head above water. At the same time, inflation will remain below 2% in the United States (1.3%) and in the Euro zone (1.1%). According to SGAM, “The output gap (difference between actual and potential output), which is a key variable to gauge inflationary pressures, should remain large for at least two years.”

Given these macro economic expectations, equity markets are benefiting from largely optimistic forecasts. The polled managers project the MSCI EM, a broad index of emerging markets equities, to return 23% between June 30 2009 and June 2010. Since the poll was conducted, the MSCI EM has been roaring along, posting a 25% return. Over the same horizon, managers’ consensus puts the U.S. stock market in second place (anticipated growth of 14% a year), followed by the Eurostoxx 50, the FTSE 100 and the Nikkei 225. By June 2012, the outlook is even brighter for U.S. stock markets, with expected growth of 30% compared to June 2009, widening its lead other developed countries.

Meanwhile, in this bull market, fund managers expect a decline of volatility, with VIX index at 24 and 23, respectively, in June 2010 and June 2012, compared to 26 on 30 June 2009.

Erratic changes in high-grade credit spreads

The prospect of managers reallocating their benchmark portfolio in favour of risky assets is also based on their interest rates expectations. Managers foresee no significant rate change until the end of June 2010, with a slight flattening of the curve on both sides of the Atlantic. “Given the magnitude of the recession, it is easy to see that we are in a phase of very low utilization of our production capacity. For now, our economic forecasts are leading us to maintain the status quo for much of 2010. While a stronger than expected rebound in activity is possible, it should not justify monetary tightening in the eyes of the authorities,” said AXA IM.

In contrast, this flattening of the yield curve could intensify by the end June 2012, with a two-year yielding 3% in the Eurozone and 3.8% in the U.S., while the rise in long rates would be limited to 4.7% and 4.9%.

Regarding the prospects for credit spreads, managers expect a slight widening in high grade spreads by June 2010 both in Europe and the U.S. The trend should then reverse itself, with spreads in the longer term divided by two, narrowing below their June 2009 levels. Expected returns for high-yield debt are even more dramatic.

Finally, managers expect WTI crude to maintain its level of early October until late June 2010, then stabilizing around $80 into 2012.

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FM consensus figures