Investors have had a lot on their plate as they juggle an unprecedented health emergency, renewed US-China tensions and a politically charged movement against racism in the US that could derail any economic recovery. Now, there is another hurdle to add to that list: inflation.

While the Federal Open Market Committee meeting on Wednesday (June 10) forecast subdued inflation levels in the near future – around 1.6% in 2021 and rising moderately to 1.7% in 2022 –experts warn that investors planning their long-term asset allocation should factor in the impact of a return of a level of inflation.

In particular, asset owners seeking to utilise a multi-asset approach will do well to weigh how a Covid 19-induced ‘new normal’ will introduce a rise in inflation because it will change the correlation between assets.

Nick Samouilhan
Nick Samouilhan,
Wellington Management

“It doesn't need to come back very much. It just needs to come back a little bit to cause some trouble, and that's something which impacts both on what asset classes you should own, and how you build the portfolio because correlations change when inflation changes,” Nick Samouilhan, a Singapore-based multi-asset strategist at Wellington Management, told AsianInvestor.

Given inflation impacts a currency’s purchasing power, it is the “nemesis” of any income strategy, for both equities and bonds, said Fidelity International’s portfolio manager George Efstathopoulos in the firm’s market update webinar on Thursday (June 11).

With the coronavirus outbreak disrupting global production, experts said the shift from globalisation to regionalisation will contribute to rising prices.

“The moment you move the production of an item away from its lowest-cost producer to somewhere else, prices have to go up by definition,” said Samouilhan.

In addition, if social distancing and mobility constraints continue to linger, investors should expect inflation to rise as well, he said.

Coupled with global central banks’ efforts to rescue their hard-hit economies with debt purchases, the prospect of the return of inflation will be an issue for asset allocation in multi-asset portfolios over the medium term.

“I am not talking about double-digit inflation, it can be low single-digits but above bottom yields, and it would be a problem,” Samouilhan noted.

This adds another risk to investors’ asset allocation plans amid the persisting low-yield environment. Government bonds yields have dropped to new lows, while a post-Covid-19 ‘new normal’ means that equities are unlikely to generate equivalent returns as in the pre-pandemic period.

Samouilhan said earnings growth might not necessarily translate into dividends over the long term, as companies will look to shift revenue away from shareholders towards workers to provide better protection.

“If you have that tilt in the focus of companies towards their workers and away from shareholders, that will also have an impact on dividends, and from the society's perspective that could be a fantastic thing,” he said, “but it will mean that from an equity perspective, shareholders will have less of the pie.”

MULTI-ASSET CHALLENGES

Asset owners have increasingly taken to the idea of adopting multi-asset strategies. China Pacific Insurance Company, for example, awarded a $500 million multi-asset mandate to be split among five fund houses in December.

“We have seen [interest in multi-asset solutions] from Hong Kong, Korea and Australia where institutional clients are looking at a much broader mandate than we had seen in the past when it was very much asset class-specific,” said Deirdre Flood, head of international distribution at Wells Fargo Asset Management.

However, investors seeking these strategies will likely also encounter regulatory hurdles, as some asset owners are required to adhere to their institutions’ investment guidance.

A gap in necessary skillsets can be a challenge for asset owners in Asia, said Samouilhan.

“Most of my interactions with clients have not been about what we can build for them; it's just talking them through how to think about things, and how do you compare the risks of a REIT [real estate investment trust] versus the risks of lending in Brazil,” he said.