Back in January we took a survey of market expectations for the year ahead. The difference from many similar surveys was that we were asking about asset class volatility as opposed to returns.
We didn’t expect these “instincts” to be accurately borne out in reality, but when we looked at the results we were interested to see whether expectations were for volatility to be greater or less than the previous year, and above or below the longer term averages since 2006.
The results suggested that people were expecting volatility across asset classes in 2013 to be higher than 2012 (when volatility was relatively low compared with longer term averages), but roughly in line with the longer term averages in 2006.
So, what happened in the first six months of the year?
Many readers will be familiar with the way things have gone in financial markets over the first half of the year. The first few months saw a relatively benign environment, with most asset classes experiencing low volatility. The exception to this was the inflation market in the UK which saw a surprise spike as CPAC announced it would not be recommending any changes to the RPI index following a consultation process. During May and June however volatility across markets increased substantially (although not to crisis-like levels) following various messages from central banks alluding to the possible phasing out (or “tapering”) of the asset-purchasing programs.
So where does that put the overall volatility that was experienced across asset classes in the first six months of the year?
What is clear from the charts above is that, so far in 2013, the volatility experienced across most asset markets is comparable to 2012, and substantially below both the long term volatilities over the period since 2006, and also the expectations from our survey.
Strikingly, Developed Market Equities (represented by the MSCI World index) saw a realized volatility of only 11%p.a. in the first six month of 2013, despite the market falls in May and June. This compares to a longer term volatility since 2006 of 19%p.a.
The one exception to the low-volatility dynamic in 2013 is Risk Parity, which has experienced volatility in line with the longer term average and expectations, and higher than 2012.
This is an interesting reminder that asset classes like Developed Market Equity, Emerging Market Equity and Commodities do experience significant volatility over the long term, and as significant as the moves in May and June this year may have felt, they still amount to considerably less volatility than investors should expect over the course of a whole year.
What about liability volatility?
On the liability side of the equation, the clear difference this year is the volatility of UK RPI, which in the first six month of 2013 has experienced an annualized volatility of 55 basis points, compared to a longer term average of around 35. This was associated with the increases in expected RPI rates following the CPAC decision not to recommend any changes be made to the RPI index, and for now at least it appears unlikely that this issue will resurface, making this a one-off event.
Fixed-interest swap rates experienced an annualized volatility of around 65 basis points during the first 6 months of 2013, which is very close to the long term average. For a scheme with (unhedged) liabilities with a duration of 20 years this would amount to an annualized price volatility of 13% on the liabilities, which is likely to be more significant on the pension scheme’s overall position than any of the asset volatilities. Most ALM risk models indicate the liabilities are the most significant source of volatility in a pension scheme’s overall position and this has continued to be the case in 2013.
No-one knows for sure what the last six months of the year will bring, but what we can say is that if history is any guide, we could be in for higher levels of volatility than what has been experienced in the first 6 months of the year.
Please note that all opinions expressed in this blog are the author’s own and do not constitute financial legal or investment advice. Click here for full disclaimer