Investment groups are increasingly concerned that the next 20 years will bring higher inflation and slower growth rates than the last two decades. As such U.S. and Canadian-based pension schemes have once again been given a reminder of the threats faced by inflation and the need to develop inflation hedging plans quickly. The popularity of more varied portfolios and the use of strategies such as infrastructure are on the up as the market takes the necessary steps to safeguard its investments.
Increasing oil and health care prices, past weakness of the dollar and Asia exporting higher prices to the West are all contributing to inflation. Furthermore, the U.S. Department for Agriculture projects that 2012 will bring an overall food price spike of 2.5 to 3.5%. Inflation-hedging characteristics and global-listed returns equivalent to CPI plus 6.3% over 20 years champion the use of infrastructure assets. Regulation, concession agreements and contracts all link these assets directly to inflation.
The second annual Inflation Hedging for Institutional Investors in North America report by Clear Path Analysis brings together 20 U.S. and Canadian-based pension, endowment and asset management experts, who alongside their institutional investment peers, examine what a heightened inflation environment means, what can be done to limit the damaging effects on portfolios and what the optimal assets are for high or negative inflation scenarios.
Jeremy Lawson, Senior US Economist and Aaron Kohli, Interest Rate Strategist at BNP Paribas Corporate & Investment Banking, note: “The U.S.economy is in an unpredictable position and the Fed faces a serious dilemma; they must devise the perfect degree of monetary stimulus to make progress on their employment mandate without jeopardising their long-term inflation target”.
They predict that: “Going forward, we expect the Fed will continue to get the policy mix right and a gradual decline in unemployment takes place without a break out in wage growth, while inflation expectations remain anchored close to 2%.”
Lawson and Kohli also make it clear that investors and managers need to have plans prepared for both scenarios: “The market does not reward investors who prepare only for the expected outcome. It is vital to explore both risk scenarios for inflation and the possibility of a steady deflation.”
In an interesting roundtable Yigal Jhirad, Senior Vice President & Portfolio Manager at Cohen & Steers, warns of the global inflation threat: “Natural supply barriers and geopolitical issues are affecting commodities. Inflationary pressures exist and we have seen food, oil and gas prices rise. So our approach is to build a strategy that is well positioned to excel in periods of high inflation, but also offer an attractive risk/return profile over the long term. However, we are not trying to call the market.”
He goes on to explain the intricacies of hedging against inflation: “The drivers of inflation are very complex and they could be monetary, cost or demand induced. In order to try to target inflation as a whole, you really need to think about having a diverse mix of real assets that would be effective in providing purchasing power protection against multiple drivers of inflation.”
Jon Ruff, Lead Portfolio Manager and Director of Research-Real Asset Strategies at AllianceBernstein, offers a similar view: “Most inflation hedges vary significantly in their effectiveness across time and different inflationary episodes. Therefore, to build an effective portfolio of inflation hedges, it’s critical to understand the key drivers of each asset and its fundamental response to changes in inflation.”
Ruff goes on to note: “Our research shows that while many different asset classes could potentially hedge against inflation, their effectiveness varies, as does their reliability. A strategic real asset portfolio should be built upon a well-diversified mix of real assets that optimize the trade-offs between risk, return and inflation sensitivity.”
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