Investment managers' global predictions for 2006

Investment managers expect 2006 equity performance in the major markets to lag behind the double-digit returns of 2005, according to a global Mercer survey.

Managers also anticipate a particularly sharp decline in the outlook for emerging markets, according to Mercer Investment Consulting's annual Fearless Forecast survey.

Investment managers from 157 firms worldwide, which have more than USD 20 trillion in assets under management, participated in this year's Fearless Forecast, an established, highly-regarded survey of economic and capital market expectations for the year ahead. The investment managers, based in Europe, North America and Asia Pacific, were asked for their global and regional views on the economy and capital markets for 2006.

Global equity markets will achieve a median 7.6 per cent* return in 2006, the global investment managers in the Mercer survey predicted, which compares to a 9.5 per cent return for the MSCI World IndexSM in 2005 and annualised historical returns for the past three years of 19.3 per cent.

Global investment managers in Mercer's survey expect the MSCI UK IndexSM to achieve a median return of 7.7 per cent in 2006, approximating the 7.4 per cent return in 2005.

UK investment managers surveyed forecast real GDP growth for the UK of 2.1 per cent, trailing projected global GDP growth of 3.1 per cent.

Global investment managers surveyed forecast a median return of 8.0 per cent in 2006 for the MSCI EAFE. (Europe/Australasia/Far East) Index, which compares with a 13.5 per cent return posted in 2005. However, there was wide variation in the predictions, from 3.0 per cent to 13.2 per cent (at the fifth and 95th percentiles). Consistent with this wide range, investment managers in all regions surveyed expect more volatility in the equity markets in 2006 compared to 2005, particularly outside the US.

US equity performance is expected to improve in 2006, but only to move more closely in line with the performance of the developed markets of Europe, Australasia and the Far East. Survey respondents managing global assets expect the MSCI USA IndexSM to return 7.5 per cent in 2006, an improvement from the 5.1 per cent return in 2005.

Turning to developing markets, the global investment managers in Mercer s survey forecast a median return of 9.0 per cent in the MSCI Emerging Markets IndexSM in the coming year, sharply below the dramatic 34.0 per cent return achieved in 2005.

Bond market yields are expected to rise, delivering a median 4.0 per cent return for the broad global bond index. However, the majority of investment managers in the survey foresee a decline in the attractiveness of corporate bonds in 2006. The best performing bond markets in 2006 are expected to be in the UK, Australia, the US and New Zealand.

The outlook for pension plans

"Public equity has been undervalued and out of favour over the last three years," observed Divyesh Hindocha, Worldwide Partner and Global Director of Consulting, Mercer Investment Consulting. "Despite the strong performance over this period, public equity continues to be the favoured asset class by those surveyed. Long bonds and credit are expected to be the poor relations. Even allowing for the inherent optimism, which tends to be part of an investment manager's DNA, the survey provides additional food for thought for pension plans as they seek to address various risks.

"Although the increase in allocation to alternative investments is anticipated to be limited, this space is rich with a diverse set of opportunities," continued Mr. Hindocha. "In addition to the 'usual suspects', such as hedge funds, managers anticipate allocations to infrastructure, commodities and other assets such as timber. This suggests that we may be some way from the day that bonds are the only game in town."

In nearly every region, the majority of investment managers surveyed expect pension funds to increase allocations to alternative investments modestly, generally by less than 5 per cent. The shift is expected to be greater in the US, where nearly 60 per cent of investment managers expect allocations to alternative investments will increase by 5 per cent to 15 per cent, or more.

Alternative classes expected to see the largest increased allocations are:

- Private equities in every region
- Hedge fund of funds in every region but Canada
- Single manager hedge funds in Australia and the US
- Real estate in Singapore and the UK
- Commodities in Europe and the US
- Infrastructure and currency overlays in Canada

"New accounting standards and funding challenges are placing pension plans under growing pressure to review their investment strategies," said Andrew Kirton, Worldwide Partner and European Head of Mercer Investment Consulting. "We expect emphasis on risk management to continue despite this, on occasion, leading to greater investment in some asset classes, notably government and corporate bonds which appear unattractive on investment grounds."

Economic forecasts

Evaluating the global economy, survey respondents predict global real GDP will increase by 3.1 per cent (median projected growth) over the course of 2006, which is in the middle of the 2 per cent to 5 per cent historical growth in global GDP. Regionally, investment managers expect the highest GDP growth in Singapore (5.0 per cent at the median), followed by the US (3.5 per cent), Australia (3.3 per cent) and Canada (3.0 per cent). Slower growth is expected in the UK (2.1 per cent) and Europe (1.9 per cent).

The 2006 rate of inflation in most countries is expected by survey respondents to be at about the same or lower levels than were experienced in the last twelve months. The highest predicted inflation rates are in the US and Australia, both at 3 per cent, while the lowest predicted inflation is in Singapore at 1.6 per cent.

A significant proportion of investment managers in every region expect a rise in client demand for integrating consideration of environmental, social and corporate governance (ESG) issues into investment decision making over the next three years. European managers view client support for ESG as being most prevalent, while those in the US predict the least client support. Almost half the UK investment managers (47 per cent) expect clients will want specialist investment strategies based on ESG analysis.

Mercer has conducted Fearless Forecast surveys in many regions of the world for a number of years. This year's global Fearless Forecast survey may be downloaded free of charge at www.merceric.com/2006fearlessforecast. In February 2006, complete ESG issue findings will be available at www.mercerIC.com

* All returns are US dollar based, and may vary in local currencies.

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