Commentary: Inflation looms large over investor sentiment

As one might imagine, the topic that dominated conversations during and in-between sessions at Mercer's Global Investment Forum Europe, was inflation. In particular, how to manage it in portfolios.

In one of several live polls, taking in the views of both in-person and virtual attendees, some 41% of institutional investors indicated they believe the global economy is heading for a period of stagflation. However, while inflation may be a concern in the short term, these fears may be overblown on a longer time horizon.

The inflationary pressures we saw before the Ukrainian crisis were the result of a demand shock that has been pushing prices up. Demand in the global economy has been very strong since the COVID-19 crisis. So, stagflation is reasonably unlikely, even given what we're seeing at the moment, and growth is going to be decent.

Investors though, must consider how to ensure their portfolios are resilient to inflationary scenarios, as governments and central banks grapple with the consequences of inflated asset markets and rising wages.

Turning to assets such as gold, sustainable natural resource equities and commodities may aid underprepared portfolios, while increasing longer-term exposure to real assets can help increase inflation-linked returns.

Following a live poll, almost half of attendees said they thought real assets would be the best asset class to mitigate the impact of inflation.

Economic and geopolitical uncertainty requires investors to consider their portfolio structure, the impact of monetary policy and evolution of global trade. The ongoing pivot of the economic center of gravity from the U.S. to China presents investors with new growth opportunities while at the same time fulfilling diversification needs. For example, Asian private equity exposure can complement portfolios by providing exposure to areas less accessible via public markets, including early-stage technology.

If given an extra 2% of capital to allocate to equities, some 53% of attendees at GIF Europe said they would overweight China equities (A shares) over a five-year time horizon, rather than overweight the U.S.

High on the agenda for many is the topic of climate transition, even to the degree that a total portfolio transition is becoming essential, with many investors increasingly needing to establish targets for emission reductions for each asset class.

Sustainable investment is an area of investment that is becoming more nuanced and complex, meaning rational decisions and a pragmatic partner are important. Engagement is one of the investment community's most valuable tools to drive meaningful change, but there is a need to be more diligent on matters such as diversity and social progression, as well as climate-related factors.

Sustainable investing is also about having an additional lens of scrutiny by thinking about the implications of the four Rs — return, risk, reputation and regulation — for all investors. For those wanting to make an impact, lessons can be taken from activist investors and bondholders. Many investors will become more "purpose-driven" and seek to make an impact with their investments to promote meaningful and measurable change.

The impact financing gap over the next decade is substantial, with the United Nations Conference on Trade and Development estimating that $5 trillion to $7 trillion is required by 2030 to meet the United Nations' 17 Sustainable Development Goals. This includes investment in areas such as biodiversity, as tremendous species decline threatens food security.

It is important for the investment community to develop a sophisticated climate transition plan — one that is not a box-ticking exercise — but one that is focused on planetary emissions and positioned as part of a broader rethinking of how we use resources. The pivot to a circular economy needs to target those areas that require the most transition and support those areas that are needed for the future green economy.

Having a concrete understanding of today's drivers of future financial developments is imperative to meet tomorrow's investment objectives. Collaboration is crucial to achieving this; and only through cooperation and co-creation can collective aims be achieved.

Jo Holden is global head of investment research at Mercer, based in London. This content represents the views of the author. It was submitted and edited under P&I guidelines but is not a product of P&I's editorial team.