Recession – Cover story


at 9%, it is hard to see how conventional gilt yields paying 1% to 2% could be attractive, unless they are hedged. It is no won- der then, that bond funds across Europe booked more than €40bn (£33bn) in outflows in Q1, according to Refinitiv. “The bond market is much more of a bubble than the equity market. And for that reason, a lot of fund managers, including pension fund managers, are probably overexposed to equities, simply for a lack of viable alternatives,” says Trow, who believes quantitative tightening could make bonds more attractive again, at the peril of stocks. “No doubt, fixed income has been hammered this year,” acknowledges Tomlinson. “But over the longer term, it really depends on where inflation is heading. It’s not a zero-probabil- ity scenario that inflation will start moderating. If that is the case and we end up in more of a grinding recessionary envi- ronment, then bonds actually might not be so bad. Most of the bad news may already be in the price,” he says. “Right now, nobody wants to catch the falling knife,” Trow says. “But if you get to the situation where short-term yields in the US are 3% and longer-term yields are 4%, then all of the sudden you have a viable alternative to simply putting cashflow into equities.” In the meantime, mitigating inflationary damages to the bond portfolio remain a key priority for investors. For The People’s Pension, this means reducing interest rate sensitivity and


credit exposure in its fixed income portfolio, while the LPPI’s bond exposures are fully hedged. But there are some snags to that. For one the supply of index linked gilts, the most pop- ular asset class to hedge inflation risks, has been limited while demand from DB schemes looking to de-risk keeps growing. At the same time, while linkers have offered neg- ative yields for the past few years, as the Bank of England raises not only nominal but real rates, prices for linkers had fallen dramatically by the beginning of this year. “Index-linked gilts can be extremely volatile and the empirical evidence for this shows that the 1/8% 2052 Treasury has exhib- ited price volatility of 23% in the past year. This is greater than UK equity,” says Con Keating, head of research at Brighton- Rock, and John Spain, a treasurer at education charity Law for Life, in a blog for Henry Tapper. They both warn of “catastrophic losses” due to falling prices. Ironically, while linkers performed well in a low yield environment, they fall short of addressing the challenge they were meant to address: inflation.


No easy answers


The best approach is to be macro-aware, rather than being macro- driven, because a kneejerk response can go very wrong.


Richard Tomlinson, Local Pensions Partnership Investments


Amid a gloomy macro-economic outlook, it appears that inves- tors have no place to hide. For now, schemes with a longer- term investment horizon plan to weather the situation without a significant reduction of their equity portfolios, given that bond markets also face a challenging environment. But equity portfolios will have to be adjusted if they are to face the coming storm. For Tomlinson, that means not only a stra- tegic focus on income, but also increasingly factoring in cur- rency risks. He predicts that amid growing global volatility, the dollar is going to rise. “Historically, when markets get ugly, the dollar tends to perform strongly, so we like owning a reasonable amount of dollars in our portfolios,” he says. For example, the LGPS pool’s Global Equities fund is dollar denominated to capitalise on the rising currency. Looking at the global macro-economic outlook, he says: “There’s a reasonable chance it could be pretty rocky for quite some time. We have a portfolio that we expect to capture up- side in the event of continued growth but should moderate the downside losses if things aren’t so rosy.” Others, including Nest, see diversification as key. “We have been increasing our allocation to assets that are more resilient to inflation, such as commodities, property and infrastruc- ture,” says Nest’s CIO Mark Fawcett. “But the important thing to remember is that pension savings are for the long term.” While the exact timing of the next recession remains unclear, investors are under no illusion that they are about to enter a much more challenging environment. For what it’s worth, Michael Burry, the protagonist of The Big Short, has now built up a $36bn (£29bn) bet against Apple and this time around, he may not be the only one.


Issue 114 | June 2022 | portfolio institutional | 21


Page 1  |  Page 2  |  Page 3  |  Page 4  |  Page 5  |  Page 6  |  Page 7  |  Page 8  |  Page 9  |  Page 10  |  Page 11  |  Page 12  |  Page 13  |  Page 14  |  Page 15  |  Page 16  |  Page 17  |  Page 18  |  Page 19  |  Page 20  |  Page 21  |  Page 22  |  Page 23  |  Page 24  |  Page 25  |  Page 26  |  Page 27  |  Page 28  |  Page 29  |  Page 30  |  Page 31  |  Page 32  |  Page 33  |  Page 34  |  Page 35  |  Page 36  |  Page 37  |  Page 38  |  Page 39  |  Page 40  |  Page 41  |  Page 42  |  Page 43  |  Page 44  |  Page 45  |  Page 46  |  Page 47  |  Page 48  |  Page 49  |  Page 50  |  Page 51  |  Page 52