Creeping inflation is a manageable threat for the time being - and could even be transitory - but two leading global pension funds say any unexpected acceleration in consumer prices could have a serious negative impact on portfolios going forward.
Australia’s Cbus told an Asian Investment Summit panel discussion on Tuesday (June 1) it believes current inflation risks would pass. But it is keeping a close eye on interest rates as markets enter unchartered territory following 30 years of low inflation rates.
“It's not catastrophic, it's certainly a bit of a shift in regime," Leanne Taylor, head of asset allocation and portfolio construction at Cbus Super Fund, said at the event organised by AsianInvestor. "What would be more concerning for us is if this became much more sustained at a higher level, [and] if it happened much faster than people are anticipating.
"So there is a very real risk,” she said .
US inflation rose to 4.2% in April, the highest rate since 2008, leading to a sell-off in equities as the S&P 500 and Nasdaq fell 2.2% and 2.7%, respectively a week after US consumer price data was released.
While Cbus said it views this increased inflation rate to be transitory for now, it and other asset owners have looked at ways to mitigate the effects.
“We've lived in a disinflationary regime for so long that it takes time both for investors and the market as a whole to get around to looking at it from a structural, long-term point of view,” said a senior executive at a second global asset owner, speaking at the event.
He noted that the assets that could benefit from high inflation were likely to be real assets, equities, as well as assets that respond well to structural or regime change.
“Government bonds in specific countries are clearly the worst place to be. But there are potential pockets [of opportunity] in credit, in equities, and also in real assets as well,” he said.
POINT OF FLEX
For Cbus, meanwhile, the low-to-no inflation paradigm may have, after three decades, simply run its course.
“A lot of funds use historical stress testing and historical scenario analysis, but I think a critical point for us is on a forward-looking basis. We've had three decades of a disinflationary environment, three decades of lowering interest rates. Arguably, we're now at a point of flex,” Taylor said.
The Cbus strategy involves working with analysts to “dovetail scenarios into their bottom-up work” and “testing the resilience of its portfolio at the individual opportunity level.”
She added that the Cbus portfolio was unique, requiring a more specialised approach since a quarter of their assets were in real estate. Their default fund, she noted, is 70% growth and 30% defensive.
“We don't have inflation-linked bonds, we could introduce that if we wanted ... But again, it's very much looking at what's going on within our asset classes in terms of what it looks like within our infrastructure, portfolio, property portfolio, or private equity portfolio.”
However, Taylor warned that from an asset allocation perspective, there is “a finite point to what you can do.
“We can’t predict with perfect foresight what is likely to happen. So we need to protect our portfolio and test the resilience of our portfolio.”
The second global asset owner executive said that investors, rather than taking a one-size-fits all solution, should take note of the different economic situations in the East and West.
“We have to look at this issue of divergence between the West and an emerging Asia. On the one hand, the likes of the US have 4.2% headline inflation, but [it is a] very different story in the likes of China, India, Indonesia, Korea, where you have positive real yields,” he said.
“So, on the one hand, we have this higher-for-longer phenomenon, particularly in North America, maybe even in Europe, and also in other parts of the world. But we have a very, very different scenario in emerging Asia,” he said.
This story has been updated.