Expert: Benjamin Suess, Investment Solutions, UBS Asset Management and Facilitator: Roderic Rennison, Rennison Consulting Ltd www.rennisonconsulting.com
As the economy picks up speed through 2021, investors could have to wrestle with some post-pandemic inflation. Therefore, are fund managers, advisers, and their clients fully prepared?
A fundamentally important point is to decide if inflation is transitory or not, as the investment strategies to address the impact of transitory as opposed to longer term inflation will be different.
UBS do not think the debate as to whether inflation is transitory will be settled for a while. He pointed to the following aspects:
- Demographics; a shift in favour of demand vs supply.
- Fiscal policy; from austerity to the joy of deficits.
- Monetary policy: from pre-emptive and forecast based, to delays and outcome based.
- The labour share of income; from the gig economy to new rights for workers.
- Globalisation: from free movement of goods and capital to matters of sovereignty and control.
- The green economy; from cheapest to deliver to greenest to deliver.
1. Will inflation be transitory or persistent?
Inflation could be transitory because:
- CPI beats largely driven by temporary factors (used cars, hotels, etc.)
- Supply response coming (commodities, semiconductors, labour).
- Ongoing structural factors take a long time to change (Amazon effect, demographics, globalization).
- Phillips Curve is 'broken'*
- Fiscal impulse falls next year.
- Ongoing low inflation outside the US.
* The Phillips curve is an economic concept developed by A. W. Phillips stating that inflation and unemployment have a stable and inverse relationship. The theory claims that with economic growth comes inflation, which in turn should lead to more jobs and less unemployment.
It could be persistent because:
- CPI beats reflect strength in 'stickier' inflation labour market strength (and wage growth) still to come.
- Commodity supply response impaired.
- A new era of monetary and fiscal support.
- Plenty of savings to put to work now and later.
- Higher inflation expectations lead inflation.
- Prolonged USD weakness.
Questions raised in the context of appropriate investment classes to counter inflation
- How high does inflation need to be before it does damage to economies? There is no right or wrong answer but more than 3% over a more sustained period would be a warning sign.
- Is infrastructure a good investment if inflation is higher? Potentially, it could be.
- Is real estate a good replacement for bond holdings. Certain types of property e.g., residential could be, but the post COVID impact needs to be borne in mind.
- Is Gold a good diversifier? Yes, but the UBS view is not to go overweight at present.
- What about using cryptocurrencies? They are too immature to be able to say if they are a suitable investment instrument.
- What about value versus growth stocks as the market moves forward? They have been good over the last 12 months.
- UBS think inflation is likely transitory in the near-term, but risks are skewed to the upside in the long run.
- This higher uncertainty is likely going to negatively impact long duration assets.
- Typical multi-asset portfolios (60% equities / 40% government bonds) are likely going to be less well diversified in such a scenario but there are ways to address this.
- Overweight sectors / factors that perform better during such periods.
- Look to add Gold / TIPS* as long-term inflation hedged on pullbacks**.
- Increase real assets vs nominal assets.
- This will be a rich environment for macro trading and active portfolio managers.