Inflation is not a major preoccupation of central banks – they have clearly specified their priorities. The US Federal Reserve will continue to purchase securities if the "labour market outlook does not improve substantially", while the Central European Bank will do "whatever it takes" to save the euro, whose existence is "irreversible".
They have been followed – and at times even preceded – by the UK, Switzerland and Japan in their implementation of monetary easing measures aimed at correcting the harshness of fiscal austerity plans or limiting the decline in the competitiveness of their industries.
Client worries
Inflation may not be high on the agenda of central banks, but the erosion of purchasing power is weighing on the minds of our clients. And for good reason: with the cost of living rising by 2% and cash earning next to nothing, purchasing power will fall by one-third in 15 years. That’s right: one-third. This is why we are increasingly on the lookout for investment solutions that counteract this damaging trend.
What is our take on this environment? Current monetary and fiscal policy, coupled with demographic effects, is posing a threat to growth over the long term. Meanwhile, public institutions are buying up risk-free sovereign bonds, with the result that they are becoming increasingly scarce. The pressure on nominal rates thus looks set to continue, in our opinion. It is unclear whether these policies will lead to a regime of high inflation, or even hyperinflation, but we can already see that the real interest rates of the large economies are already negative or close to zero.
Central bankers are leaning with all their might on the yield curve, but the consumer price index is not quite so malleable. In the United States, for example, it has risen by 2.2% on average over the past five years, compared with 2.1% in the European Union (EU) and over 6.2% in the four emerging markets that make up the BRIC. Over the last twelve months, consumer price growth has topped 3.4% in the United States and 3% in the EU. And what about Switzerland, you may ask? Given the drop in inflation, it has escaped the trend towards negative real returns – with a value of 7.0% – because the franc is strong and the economic recession has submerged Europe. From a historical perspective, however, let us not forget that inflation in Switzerland has averaged 2.5% since 1946.
Safeguarding portfolios
Faced with this unique situation, what do we envisage for our clients? In an environment like this when inflation remains measured, we are gearing investments towards "generating" income. We are not eliminating equities, however, because they have the ability to respond favourably when inflation rises. With that in mind, we are adopting a portfolio construction that favours risk diversification among bonds and equities as well as among industrialised countries and emerging markets.
In any case, we are targeting our investments at quality companies identified via a stringent research process, whose revenues are of a sustainable nature, whose debt has solid fundamentals or whose distribution policy offers predictable dividends. Our approach has led us to base the construction of our portfolios on risk allocation rather than capital allocation, to give preference to high-conviction positions, and to actively manage exposures. This allows us the flexibility to direct portfolio activity towards sources of inflation during phases when inflation is more pronounced, such as, for example, more cyclical equities from the energy, materials and commodities sectors.
At the present time, the income generated meets the requirement to defeat inflation. The advantages of this construction are manifold: the portfolio return is higher than that generated when exposure is restricted solely to developed markets and the risk of losing value is lower than when the holdings consist exclusively of equities or emerging markets. Our Asian clients are fond of this approach since it aims to achieve a return that allows them to protect their purchasing power over the long term. European and Swiss clients are not indifferent to it, either, because inflation transcends national borders. Nowadays, it affects us all.
