Money management executives are adding inflation protection back into their portfolios, but they are divided as to their motives.
Some say they are concerned that economies may be about to reflate, albeit from a very low base, with U.S. inflation hovering around 1.1% and the U.K. stuck at 0.6%. Others say markets are not pricing in the risk of an inflation hike, and the opportunity to add inflation protection into portfolios is just too good to pass up.
“We think the slowing rate of growth in world trade, slowing productivity growth and productivity potential store up a potential problem for inflation in the long run,” said Simon Hill, London-based chief investment officer and senior investment consultant at Xerox HR Services. “We have been advising clients to not reduce or allow to fall away any inflation protection they have got, and to use opportunities to top up inflation protection.”
Other consultants said they are wrestling with the question of inflation due to increasingly accommodative monetary policy and the increased likelihood of further fiscal policy.
“We have been thinking about the world as being deflationary from a medium-term perspective,” said Tom Brooke-Smith, senior investment consultant in London at Willis Towers Watson PLC. “We still hold onto that global deflationary picture, but we have started to talk about an inflationary downside event, whereby we see growth being hit by a moderate shock that causes a growth slowdown, and central banks look to offset that with significant monetary printing. If that gets priced into inflation expectations, that has the potential become inflationary over the medium term.”
Wills Towers Watson has now started to add inflation protection into portfolios, having already been advising clients to hold protection for deflationary downside potential.
“So if U.K. clients are buying nominal Treasuries, we are recommending they diversify some of that into” Treasury inflation-protected securities. That is currently loosely weighted as one-third inflation protection and two-thirds deflationary protection. “We still expect deflation to be more likely, but inflation is coming into the picture in our minds,” said Mr. Brooke-Smith.
A number of executives agreed that global markets are at an inflection point. Tommaso Mancuso, head of multiasset at Hermes Investment Management Ltd. in London, thinks markets are at an inflection point for a return to inflation. With the consensus being that governments will begin to extend fiscal policy, that could be the catalyst for the return. “It is an always-present risk, and we could be at an inflection point. Inflation is the ultimate destroyer of value, and it is hard to predict, but there are indicators of where we are in the cycle.”
He said prior to the U.K.'s vote to leave the European Union might have been a good time to buy inflation protection. Brexit “helped to bounce expectations of inflation — but we think the trend was there anyway. Long term we are suggesting you should have inflation protection all the time.” He added that trend is even more so now that central banks have clearly stated their intention to seek an inflation overshoot, and will therefore remain behind the curve. The manager's multiasset fund is essentially a diversified growth fund with an inflation overlay.