From predictions of economic growth to a view of future gilt yields, institutional investors are conditioned to follow forecasts and invest in the expectation of outperformance. And forecasting the future is a widespread activity among credit investors seeking an extra edge, particularly in fully-valued fixed income markets.

 

But the problem with forecasts is that they are an absurd notion. The global financial and economic system is bewilderingly complex; no amount of crystal ball-gazing can generate consistently accurate assessments of what will come to pass 12 months from now.  For example, in December 2013 economists’ consensus forecast for 10-year gilt yields at the end of 2014 was of 3.2%. For the following 11 months, 10-year gilt yields averaged 2.6%, dipping below 2% in October.

 

One might think that central banks would be a good source of reliable forecasts, given the centrality of forecasts to their setting of monetary policy. And yet central banks are not, in fact, very good at producing consistently useful forecasts. Nor should they be, I would argue. This is absolutely not a criticism; I merely contend that it can’t be done.

 

It appears that central banks are themselves facing up to this. The Federal Reserve and The Bank of England both now talk to about ‘trigger levels’ for policy response. For example, Mark Carney announced a series of economic triggers, such as unemployment falling below 7%, which could cause base rates to rise. To me, this is a tacit admission that they will no longer rely primarily on forecasts in order to set monetary policy.

 

If the most scrutinized forecasters, with access to the widest and deepest range of information, struggle to predict the future, and if we accept that we have no reliable insight into what is to come, then what is really important for investors to consider? The answer is value, and the critical question in searching for it is: where is risk adequately rewarded, and where is it not?

 

Taking this as a starting point, a resulting ‘bottom-up’ approach to investment in credit enables investors to buy and sell based solely on value opportunities in the market. It responds to events rather than trying to predict them and thereby focuses investment decisions on what is knowable (facts), not on the unknowable (the future). This approach is certainly resource-intensive (it takes manpower and deep credit research capabilities to assess each opportunity) and it requires patience (there are times when markets do not present many opportunities where risk is adequately compensated). But all our experience shows that patience is rewarded, and the approach delivers repeatable, sustainable excess returns.

 

So, for credit investors, there are really two follies of forecasting: one, that it can be done and two, that it is needed.

 

For investors who eagerly await the plethora of investment outlooks for 2015, remember that forecasters not only need to get it right once, but to repeat their successful forecasts year after year. As Niels Bohr, Danish physicist and Nobel Peace Prize winner, surmises so succinctly: “Prediction is very difficult… especially if it’s about the future.”