The sixth-annual Investment Magazine CIO Sentiment Survey has found the investment chiefs of Australia’s largest institutional asset owners are wary of a pullback in equity markets and rising interest rates. However, they are more confident of meeting return targets for the year ahead than they were 12 months ago.

The survey was open to the investment chiefs of the 100 largest institutional asset owners in Australia, New Zealand and Papua New Guinea. It attracted 38 online responses during a three-week period in October, from CIOs who collectively manage about $830 billion. Most respondents were from local superannuation and pension funds. The survey was produced in association with Frontier Advisors.

It found that more than 40 per cent of CIOs said a fall in equity markets was their greatest concern, and another 16 per cent nominated it as their second-biggest concern.

This ranked ahead of rising interest rates, nominated by 32 per cent of CIOs as the biggest risk, and geopolitical issues, ranked as the number one risk by 13 per cent. The risk of a corporate credit crisis and the possibility of ultra-low global growth rounded out the top five.

Frontier Advisors director of investment strategy Chris Trevillyan said concern about a fall in equity markets reflected how large an exposure funds currently have to equities. And he said rising interest rates are “definitely a key medium-term risk”.

“The catchphrase we’re hearing of late is ‘quantitative tightening’, which is the reversal of quantitative easing,” he said. “That’s a key theme, because post-global financial crisis it’s all been about the liquidity those central banks have provided.”

The survey revealed most CIOs are optimistic about the likelihood of reaching their balanced funds’ return targets, reflecting the fact that 40 per cent of funds have reduced those targets to more realistic levels during the last year.

Overall, almost 60 per cent of CIOs believed they would meet their target, a near-doubling of the level a year earlier. Only 5 per cent of CIOs were expecting to miss their target, with the remainder uncertain.

Only 12 per cent of CIOs said they planned to reduce their target in the year ahead, and 87 per cent said they were not planning to take on more risk to meet their target.

Most CIOs are aiming to beat the Consumer Price Index (CPI) by 3 percentage points, suggesting a nominal return target of 4.8 per cent at current inflation levels, or 5.5 per cent assuming a CPI at the mid-point of the Reserve Bank of Australia’s long-term target inflation range. The survey revealed target returns ranging from CPI plus 2 per cent, to a nominal 8 per cent.

SuperRatings chief executive Kirby Rappell told Investment Magazine funds face a challenge in explaining to members what a target return means. He said funds usually assign probabilities to hitting targets, which members may not understand.

“[The challenge is] getting alignment between what a member thinks the probability of hitting a return target is and a fund’s [understanding],” Rappell said. “We’re finding that as there’s a greater focus on funds diversifying their portfolios to be able to deal with more challenging market conditions, and obviously not being quite as heavily tied to pure equity exposures. It’s creating quite a challenge for how investment outcomes are aligned with member outcomes and what members are expecting from their funds.”

Trevillyan said a key factor in funds meeting targets would be how successfully central banks can raise interest rates without triggering a debt crisis.

“If it’s shown in the next few years that central banks just are not going to be able to get back to those [historical] interest rates, because of how much debt there is in the system, that means people will have to readjust further and reduce their return [targets],” he said.

Geopolitical impact hard to figure

Among specific geopolitical risks identified in the survey, CIOs were most concerned about the impact on global markets of US politics, slower growth in China and North Korean aggression.

However, respondents noted a distinction between the likelihood of an event occurring, and the impact it could have on their portfolios; for example, Trevillyan said the impact of a North Korean nuclear conflict would be “obviously huge, but then what probability do you assign it?”

Likewise, the global impact of US politics: “How big a threat is it really, and how much of it is media and publicity?” he asked. “We are seeing so much [coverage] of it, while perhaps…slower growth in China could well be the bigger threat, but it’s just not getting the publicity.”

European Union-related issues rounded out the top five geopolitical worries, with CIOs reflecting concern over ongoing fallout from Brexit, and the possibility of other member states leaving.