More than two in three institutional investment managers expect oil prices and market volatility to rise over the next six months, with a corresponding increase in near-term inflationary risk.

About 70% of global managers in a quarterly survey by Northern Trust believe the risk of inflation will increase over the next six months, while 62% expect market volatility, as measured by the VIX Index, to increase in the same period.

The responses for both questions have touched their highest levels since Northern Trust began its survey in the third quarter of 2008.

More than half of respondents expect oil prices to rise, with 90% of managers saying increased oil prices will negatively impact economic growth. In all, 26% increased portfolio exposure to commodities in the first quarter this year.

“With renewed unrest in the Middle East, it makes sense that managers have become increasingly concerned about the impact a spike in oil prices will have on economic growth,” says Chris Vella, global director of research for Northern Trust Global Advisors (NTGA), the multi-manager investment arm of Northern Trust.

“Likewise, as general concerns around inflationary pressures persist, we would expect some of our managers to increase exposure to commodities as a means to hedging out some of that risk.”

Managers remain positive about US market valuations. The majority (58%) stated that the US equity market, as measured by the S&P 500 Index, is undervalued.

However, there was a decrease in managers who believe corporate earnings will increase over the next three months, from 80% in the fourth quarter of 2010 to 69% in the first quarter of 2011.

Looking at Japan following the March 11 earthquake and tsunami, two-thirds of managers believe Japanese equities are undervalued. There was also an increase from previous quarters in the degree of perceived undervaluation, as 31% see more than 10% upside in Japanese equities – a 12% rise from the previous quarter.

The survey also found 36% of managers describe themselves as more risk-averse, compared with 20% last quarter.

The percentage of managers who believe emerging markets are undervalued rose slightly from 39% in the fourth quarter of 2010 to 43% in the first quarter of this year.   

Roughly 66% of managers said their portfolio concentrations were the same as last quarter, while 21% stated that their portfolios were more concentrated, down from 24%.

The survey of 88 institutional managers was conducted in mid-March by NTGA. Respondents included fixed income and equity managers across value and growth styles, with a bias towards fundamental, bottom-up stock picking strategies.

NTGA offers multi-manager solutions and had $41.2 billion under management as at the end of 2010 for institutional and personal clients.