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Monday, January 31, 2011

As Economy Recovers, Managing Risk Will Be Critical

January 7, 2011

Managing risk with be the trend in the investment management business in 2011, said Ed Keon, managing director and portfolio manager for Prudential Financial's Quantitative Management Associates, at Prudential’s 2011 Global Economic and Retirement Outlook briefing in New York City on Tuesday.

Although Keon believes the economic recovery is gaining traction in the U.S. and globally there is much that can go wrong. “There is stuff we can’t even imagine right now, like the sovereign debt issue we couldn’t have imagined last year,” he said. “We are trying to deal with budget problems and housing prices are still weak. We will likely overcome these things and the economy will look better next year than it does now.”

One fear, Keon pointed out, is that some feel the aggressive actions by the Federal Reserve will lead to inflation going forward. Yet he thinks the odds of inflation increasing in the next year or two are miniscule. That’s because inflation spikes in the 1970’s and 1980’s were accompanied by a spike in labor costs, which we are not seeing currently. In four to six years from now though, inflation could be a worry, he added.

“The events of the last year have made the situation worse not better,” Keon said. “In the case of downstream inflation the problem is we have destroyed a lot of human capital over the last few years. New grads are not getting jobs and people in their fifties and sixties are losing valuable job skills. The crunch may come in the next few yrs.”

Meanwhile, many have been touting the benefits of investing in emerging markets because of their strong growth rate and demographics, but now the fear is that overinvestment has created a bubble. Keon predicts emerging markets will make a good investment because there is a surplus of labor and capital, which leads to ideas and innovation. “Emerging markets have the ability to take ideas already established in other countries and use them in their own way,” he said.

Another market whose end many have been predicting is the bond market, but Michael Collins, senior investment officer, credit strategies, for Prudential Fixed Income, says the bond market is “alive and well and here to stay.” “I am fairly optimistic on the bond market over the intermediate and long term,” he said on Tuesday. The reason: demographics. The 2010 census, which was recently released, said the population is growing at 1%. With half the population leaving the workforce, it will be difficult to sustain a strong economic recovery, he said, and bond yields are correlated with economic growth. In the meantime, as baby boomers get older they will be looking to protect their investments for retirement and begin shifting more to bonds. Another plus for the bond market, Collins said, is that the U.S. is the world’s bond market. “We see money coming in from China, Japan, and the Middle East. Other countries that have a lot of cash capital and need something to do with it give it to us because that’s where the opportunities are and to some extent that’s where the yield is.”

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