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US Debt Deadlock: A Big Fat Tail

April 8, 2013

Commonfund, the Wilton, CT based institutional investment firm and advisor, released new survey data on the (rather upbeat) institutional investor expectations for 2013.

Investors expect on average that their own portfolios will grow 7.6 percent in 2013. What may be more intriguing to some: they aren’t as worried about Europe as they were last year. They still worry about fat tails, but the focus of that worry has moved west across the North Atlantic.

Their expectations for their own portfolios are somewhat lower than their expectations for the 1-year return on the S&P 500. On the average, they anticipate that the S&P will return 7.9 percent this year. The median forecast is just a bit higher: 8 percent. The range of responses on the S&P was wide, with some respondents expecting 0 percent return, and others going as high as 16 percent.

When asked what they expected from the S&P over the next three years the respondents were both less optimistic on average and less scattered in their opinions than in answering the one year question. They expect 7.1 percent average annual return over three years, and 43 percent of the respondents expect the figure will be between 7.0 and 8.0 percent. Nobody expects less than 2 percent or more than 12 percent annual return over that period.

Since Last Year

This is the third annual survey of its type. The respondents have changed their view of the most pressing tail risks from last year to this. A year ago, 32 percent of the respondents saw an EU crisis as the most significant risk going forward. That number has fallen to 11 percent. On the other hand, in 2012 only 23 percent said that Washington gridlock on U.S. debt was the most significant concern. That number has risen to 38 percent.

Some punditry notwithstanding, respondents did not and still don’t have China on the top of their worry list. Only 2 percent put it there last year, and the same figure held this year.

Expectations for specific assets and indices have also changed a good deal in the last year. For example, expectations for hedge funds are down. Last year, 30 percent of respondents said that hedge funds, that is, the HFRI Fund Weighted Composite, would underperform the S&P over the course of the following three years. That figure is up to 37 percent. Conversely, in 2012 the same number, 30 percent, expected the HFRI to outperform the S&P. That number is down to 26 percent.

Percentage of respondents cited as most significant fat tail:

Expectations for commodities vis-à-vis the S&P are also down. In 2012, 17 percent of respondents said that commodities, that is, the Dow-Jones UBS Commodities index, would underperform the S&P. That number has more than doubled over the year, to 37 percent. Conversely, last year 44 percent said that commodities would outperform the S&P. This year, that number is down to just 27 percent.

Relative to your expectations for the average annual return on the S&P 500 Index over the next 3 years, indicate whether you believe the following market/indices will underperform, match, or outperform the S&P 500 Index.

Mean and Median

But let’s return to the expectations of most concern to the respondents themselves, that is, for their own portfolios. As I noted, they expect on average a 7.6 percent return this year. The median expectation is only 7 percent.

That gives us an excuse for a brief lesson in statistics. The median is the middle value in a range. So for example, (making up numbers): if only five institutions were surveyed, and their expectations for the year’s portfolio growth were: 4.2; 5.2; 8.0; 8.5; and 8.6, the median would be 8. (In that case, by the way, the average, or mean, would be 6.9.)

In an idealized “bell curve” the mean and median are of course the same, the top point of the bell.

The median will be above the mean if there is an outlier at the bottom end of the range that is, so to speak, dragging the mean down, and there is no corresponding outlier at the top end. The median will be below the mean if the reverse is true, if the outliers are the optimists.

Commonfund collected its survey data from 217 attendees at the Commonfund Forum in Hollywood, Florida, representing nonprofit institutional investors and pension funds with combined assets of $123 billion.