Inflation – Cover story
“As well as having some direct commodity exposure, many of our equities have strong pricing power and are able to pass on increased costs to end consumers,” she adds. “A portion of our alternatives in areas such as infrastructure and renewables have inflation-linkage embedded in their long-term contracts. We also have gold in our stabilising layer which is a time-tested inflation hedge.”
Extreme caution
In any crisis, and in any market reaction to that crisis, an important factor would be how you went into it. If you went into it long of risk assets and risk assets suffer, then you will be lick- ing your wounds. If you went into a crisis short of risk assets and they re-priced, then you may be eyeing the opportunities that could lie ahead. “The situation that we are in at the moment is quite difficult to analyse and draw firm conclusions from,” Lloyd says. “Not only is the future especially uncertain but even if you could map it out reasonably accurately, it would still be difficult to have a clear view of what it means for asset prices.” Much also depends on the investor and the overall investment approach. “From the perspective of a value investor, which I am, you look at the opportunities that have presented them- selves following the repricing of assets,” Lloyd says. “At the moment, we have not seen an adjustment in prices of suffi- cient size and have not had the big blow-off selling of assets that we saw in previous crises.”
Also, the value signals are still pretty tepid, Lloyd says. “Bear- ing in mind the possibility of significant increases in interest rates, which might come through from central banks. Extreme caution, waiting and keeping dry powder is warranted and is a sensible thing to be doing at this stage,” he adds.
Changing prices
The rise in inflation has inevitably scuppered the returns on some investments. “There’s been a lot of nerves over inflation and the path for interest rates, and the first quarter of 2022 has seen equities struggle with some of these headwinds,” Mitchell says. “There are not many assets that do well or are unaffected by quickly shifting global conditions. Equities are not immune from inflationary or growth shocks over the short term.” Having analysed the situation for Nest, the majority of the investor pain so far has been in the bond markets, Mitchell says. “Higher yields in bonds means lower prices, which lead to negative returns,” he says. “On a hold-to-maturity perspec- tive, the current level of yields and inflation means investors are still locking in negative real returns with government bonds and investment-grade bonds.” From a portfolio construction perspective, another major implication of higher yields might mean that the stock-bond correlation returns to positive. “Investors have benefitted from
If there is one country in the developed world most at risk of a stagflation- type scenario it is probably the UK.
Evan Guppy, Pension Protection Fund
a 20-year period in which when stocks fell, bonds were likely to rise,” Mitchell says. “But prior to this, when inflation was per- sistently higher and more volatile, the stock-bond correlation was positive. If this environment were to return, then investor portfolios would lose that diversification benefit.”
The patient investor Portfolio adjustments are part of the evolving situation for investors. “We recently added back a position in gold and, within our equity selection, are increasing our focus on compa- nies which will weather an inflationary backdrop and even thrive,” Newton’s Doyle says. “We have bolstered our exposure to the energy sector and will avoid companies whose business models are likely to be vulnerable to rising cost pressures.” Nest finds real assets appealing. “At Nest we are thinking about the implications of a shift to higher and/or more volatile infla- tion regime,” Mitchell says. “It could mean a greater role for assets like real estate and infrastructure, that have implicit or explicit positive links to inflation.” For Lloyd, the uncertainty of the situation is a major challenge. “There’s an awful lot of further unknowns around global sup- ply chains,” he says. “The long-term impact of sanctions, for example, which are almost impossible to estimate at this point in time, not knowing their duration or whether they will con- tinue to be in place or even the extent to which they might bite into the economies of the developed nations.” Therefore, he suggests, patience is an important investor vir- tue at this point. “Patience is likely to be the best strategy. And potentially, in the long-term, the best-rewarded strategy.”
Issue 113 | May 2022 | portfolio institutional | 19
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