Canadian investment managers predict equities to outperform bonds, but expect moderate returns for both asset classes in 2005, according to a forecast released today.

The forecast, which was conducted by Mercer Investment Consulting in December 2004, includes predictions and views on the Canadian and global markets from 48 leading Canadian institutional investment managers. Together, these firms manage over $600 billion in Canada for pension funds and other investors.

Bond and cash market returns are predicted to range from 2.0% to 4.0% while managers anticipate equity market returns to range from 7% to 8%. Canadian and emerging equity markets are expected to lead the way.

“Managers are expecting 2005 to be a solid, but not outstanding year. Interestingly, the majority of managers, 58%, also expect Canadian equity markets to be more volatile than last year. This may be a function of 2004’s relatively low volatility,” said Wes Peters, a senior consultant with Mercer Investment Consulting, in a release.

“Throughout 2004, the strength of the Canadian dollar made headlines,” added Peters. “While managers expect only a marginal appreciation for the Canadian dollar versus the US dollar in 2005, they see the loonie’s strength as the number one issue impacting Canadian capital markets in the year to come.”

The performance of the Canadian economy and a number of international issues, including the stability of world currency markets and the performance of the Chinese economy, are also expected to influence capital markets in 2005 for Canadian investors. These international issues ranked ahead of U.S. and domestic interest rates and inflation.

The survey also reveals that a majority of managers expect merger and acquisition activity to increase in 2005, led by consolidation in the energy and materials sectors.

As for interest rates, the managers predict an increase of 0.75% in both the Bank of Canada rate and the U.S. Fed Fund rate, with the Bank of Canada rate at 3.25% and the U.S. Fed Fund rate at 3.0% by year end.

The majority of managers expect energy and materials to be the top performing sectors, with the utilities and telecommunications sectors anticipated to be the worst performers. Large and small cap Canadian equities are both expected to perform modestly, with the S&P/TSX Composite and the Nesbitt Burns Small Cap Index expected to show one-year median returns of 8% and 7% respectively.

While there was no overwhelming consensus on the top performing Canadian large cap stock, Nortel Networks, Manulife, BCE and Royal Bank are expected to be strong performers.

The Canadian investment managers survey is part of Mercer Investment Consulting’s annual survey of global investment managers. Global survey results will be released later this month.