Dominated by pandemic-induced volatility and unprecedented monetary stimulus, investors have had to adapt to rapidly evolving global markets over the past two years. From the shift in consumer spending habits, to expansionary central bank and fiscal policies, alongside corporate and government pushes for a greener future, investors are having to process a wide variety of factors to find new ways to generate yield while future-proofing their portfolios.
Following a recent M&G Investments roundtable – hosted by fund manager Randeep Somel – we have pulled together some highlights from the discussion between Fabiana Fedeli, CIO of equities and multi asset, Jim Leaviss, CIO of Public Fixed Income, and William Nicoll, CIO of Private and Alternative Assets.
US inflation recently hit 7% for the first time since 1982. What do increasing inflation expectations mean for investors?
Jim Leaviss: Inflation is the enemy of fixed income investing. There are some things that investors can do to hide from inflation, through inflation-linked bonds and floating rate notes, for instance, but it is a bad environment if this inflation turns out to be structural rather than transitory. Bond markets have been working on the assumption that it was going to be transitory, and yet the numbers keep coming in relentlessly high. Especially in the US and the UK. European inflation is a bit more subdued than it is in the rest of the world, and will probably stay that way. Fund managers on the whole were expecting the post-COVID-19 recovery to be similar to the long drawn out recovery from the Global Financial Crisis. However, it has turned out to be a quicker and more significant rebound, leaving central banks in a tough position. It’s probably right that they’re hiking rates now – at least getting back to where they were before the pandemic, because there isn’t really any great reason to have the emergency rates that we had before. The real quandary for central banks will be what happens beyond that – and I think they are in danger of making a policy error if they do move too quickly and too aggressively at this point. You could argue that this inflation is actually going to be what causes the next recession or downturn in growth, rather than a response to strong economic growth.
Also, if you look at the UK, wages are going up – but not up by as much as inflation. The same is true in the US – with some states at nearly 10% inflation. That’s going to be a huge drag on workers’ incomes and is potentially President Joe Biden’s biggest problem as a politician: What to do about this inflation wave and its erosion of living standards for Americans? In the UK, we also have things like tax increases and higher mortgage rates, and the biggest problem for central banks is that they can see this huge wave of inflation – but what will putting up interest rates actually do to address those things? So there are clearly some big questions about the transmission mechanism and what the point of hiking rates would be at this point in the cycle.
Fabiana Fedeli: From an equities perspective, it’s not inflation that is the key variable to watch, but the growth outlook that surrounds that inflation. As long as the growth outlook remains constructive, as is currently the case, this is good for equities – particularly given that, from a relative valuation standpoint, equities are faring better than most other asset classes. Of course, if inflation has a negative impact on the economic outlook, or there is a policy error along the way (whereby the central banks tighten too much, too fast), that would change the narrative for equities. For our multi-asset portfolios, we are positive on equities but we are also diversifying across other asset classes, taking positions in bonds – particularly where we can find some higher yields, such as emerging market bonds. At the same time, we’re keeping some cash as dry powder in case we see another market sell off that opens up potential opportunities in interesting areas.
Will Nicoll: For private assets, the impact of rising inflation depends on what part of private markets you are talking about, and whether you are investing in real assets or debt. If you look at infrastructure equity, a lot of income is directly linked to inflation – so that’s an exciting place to be. Similarly, if you are looking at real estate – there is a discussion to be had about how much inflation will filter through into rents and “real” parts of the economy. On the other hand, with regard to some of the private bond markets, it is clear that there are areas that are quite highly levered – and in some cases extremely highly levered. Therefore, if you start to see inflation coming through, along with the expected policy response, then it would be unusual not to see little pockets of distress. So far, none of that has come through and there’s still a wall of money available to refinance, but to reiterate it is very much going to depend on whether you are invested in real assets or whether you are invested in debt. The private markets have a greater expanse of leverage, when there is a fundamental change in interest rate policy there will always be someone who is over levered as market dynamics change.