The chief executive of Australia’s $200 billion sovereign wealth vehicle the Future Fund has reiterated a warning that the investment community must avoid complacency in the face of persistent high inflation.
Raphael Arndt, who is also the Future Fund's chief investment officer, said a reliance on traditional assets and plain vanilla strategies would not help counter the risks of inflation, and that adhering to traditional 60/40 equity/bond portfolio construction was no longer sufficient to ensure returns would match expectations.
“There is no such thing as a risk-free asset any more," Arndt said in a statement on Monday. "Just buying bonds isn’t going to protect you, and there’s every chance we’re going to see bonds settle at a level that has a negative return.”
Arndt’s cautionary words chime with those of other Australian investment experts.
“We’ve had a decade of low inflation, where people have been less aware of the effects of inflation on various asset classes,” David Carruthers, principal consultant at Frontier Advisers, told AsianInvestor.
“Investors should go back to their analysis of whether, for example, equities are a hedge against inflation. They need to understand how asset classes actually perform in periods of high yield and high inflation," he said. "It’s coming back to a really interesting question at the moment, based on the fact that we're still getting negative real yields out of bonds."
Although low rates have been an issue for fixed-income holdings for some time, the potential for inflation getting out of hand is a fairly new problem – one that can significantly impact risk assets as well as long-duration bonds.
The bottom-line advice for those concerned about inflation is to diversify, Carruthers said.
As investors look to alternative assets, there is now more interest further up the risk curve, where much of it was previously focused on defensive alternatives.
"Investors are looking for uncorrelated diversifying strategies, ways to hedge equities without paying too much for the protection," Alex Zaika, GAM Investments' managing director for Australia, told AsianInvestor.
"There's a big focus on replacement fixed-income products, which includes insurance-linked securities," he said. "Institutions, especially super funds, are buying a lot of private debt, given it is benchmarked against the global aggregate index. Non-pension institutions, meanwhile, are seeking more customised alternative solutions to hedge equity drawdowns and provide portfolio diversification."
Another emerging trend in Australia is the disintermediation of banks, the traditional lenders to business. More stringent risk capital requirements in recent years have seen banks pull back from this activity. Super funds and other big investors have moved into the space.
"You can get into really high-risk stuff there, but what we're typically seeing is bank disintermediation," Carruthers said. "As an investor, you're picking up credit risk, illiquidity risk and single-issuer risk, so you need to diversify."
Commodities and natural resources are also getting attention. The Future Fund has increased its commodities holdings, including gold, Arndt said.
Resources have been viewed as a traditional hedge against inflation, but according to one specialist manager, they're also an area of expertise that has been dwindling over the past decade.
“It’s not an area that a traditionally trained fund manager can really manage," the manager said. "Our resources sleeve is run by a trained geologist. The global push towards [environmental, social and governance], impact investing and renewable energy is a huge tailwind for this area as well.”
With private market investment, the problem is access to opportunities in the local market, where the biggest deals are carved out by the big institutions.
“There has been a shortage of good liquid alternatives available for Australian investors, so many have opted for illiquid alternatives like private equity and private debt," Zaika said.
Smart beta-type strategies have not sustained their appeal in Australia. Several Asia-Pacific institutions have utilised investment strategies such as factor tilts and smart beta in recent years, including the Future Fund. But analysis by Van Eyk Research suggests that although single-factor strategies work in global markets, in Australia they don’t work so well because the ecosystem of companies is too small.
Stock and sector concentration, alongside the limited size of the Australian equities scene, were the reasons factors such as "quality" and "dividend growth" factors had not achieved outperformance in Australia, the company said.
Even though the willingness to embrace different factors is present, the problem of finding value within individual factors is likely to be challenging at points in the market cycle, according to critics of smart beta. It is difficult to sustain outperformance in factors such as "value" or "quality" through a range of different market cycles, so factors need to be rotated over time.