Private clients lacking inflation protection

Panellists at AsianInvestor's debt investor forum last week debated this and other concerns facing institutions and wealthy individuals in terms of their fixed income exposure.
Private clients lacking inflation protection

High-net-worth individuals do not tend to have as big a focus on inflation as investors such as insurers or pension funds, since the latter two types of firms have large known liabilities they have to match assets to.

But Asian private clients should be more concerned on this front, said Matthew Nest, Asia head of account management at Pimco, speaking on a panel at AsianInvestor's debt investor forum last week. Inflation hits their future spending power just as it makes it harder for institutions to meet their future liabilities.

Even institutions that are more aware of the damaging potential effect of inflation on asset values should be concerned about their exposure to riskier assets such as high yield, he notes.

“If we get an inflationary economic scenario, most HNW portfolios don't have any protection for that type of environment,” says Nest. “Most are heavily dependent on traditional equities or nominal government bonds in developed markets, both of which will probably perform very poorly in an inflationary environment.”

That said, Asian private clients are at least more heavily invested in fixed income than in the past. “In general, nowadays our clients have about 20% in fixed income,” says Peter Lee, head of Asian fixed income at Societe Generale Private Banking, also on the panel. “In the past that was probably single digits.”

Another panellist – Vijay Jote, credit strategist at Citi Private Bank in Hong Kong – notes that Southeast Asian clients tend to be more fixed-income-orientated than those in North Asia, where the allocation may still be in the low double-digits or single digit percentage range.

As for how best to protect against inflation, Nest says short-dated instruments such as deposits or floating-rate notes have in the past been good hedges, because as inflation rises, central banks raise rates, and floating-rate instruments benefit as a result.

“The difference today for most investors is that inflation is running at 5% and central banks are keeping policy rates at zero,” says Nest, “so there's a huge gap between floating-rate yield and the inflation investors face.

“It's pretty clear that most central banks – in both developed and emerging markets – are moving towards further [monetary] easing rather than any question of tightening any time soon.

“The longer we are in this environment, the more capital is allocated to areas where maybe it shouldn't be allocated, and the more the distortions grow,” adds Nest.

He cites credit as a good example. “The appetite for credit is enormous from both institutional and wealth management clients, and it's getting to the point where you have to start to question the value of those types of investment.”

“The question is, when things turn, how quickly will everyone realise they're exposed to leveraged high-yield risk and what that means for their savings?”

Lee and Jote note this is a concern but not a major issue. For example, “very few” private clients have leveraged high yield in their portfolios, says Jote, although he does add there could be concerns over leveraged investment grade exposure. “But in the overall scheme of things I have not yet seen leverage [in their portfolios] at more than 30-40%. So it's still very manageable.”

Lee makes a similar point. “After the [2008] crisis, most of our Asian clients learned a lesson – so now they are more focused on risk, they don't want too much leverage. They've been looking at putting something less volatile in their portfolios, with a more predictable cashflow. They are moving to allocations more like those in European client portfolios.”

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