In the week Joe Biden officially took the keys of the White House, experts are warning investors to brace themselves for a return of inflation.
Last week it was revealed that Smith & Williamson Investment Management’s Managed Portfolio Service (MPS) has added a position to BlackRock’s Gold and General fund in anticipation of resurgent inflation over the next few years.
Iboss meanwhile has been making changes to its fixed income holdings and cash position as it prepares for what Chris Metcalfe (pictured), investment and managing director, describes as “the most inflationary environment we have had for years”.
Debt dream team
“With Biden and Janet Yellen we basically now have the debt dream team,” Metcalfe says. “The new administration has the highest debt level in history, but all the early talk is about spending more money not less.”
Add the Covid pandemic into the backdrop and Metcalfe says he cannot see there being any pushback against loose fiscal monetary policy and the official start of Modern Monetary Theory (MMT) as government policy.
“The main point about MMT is that it is not like quantitative easing (QE),” he says. “Where QE just pumps up prices, this time money is going to the people who need it and want to, or absolutely need to, spend it.”
With inflation already being seen in areas such as food and lumber prices, Metcalfe adds the last part of the jigsaw will be a rise in “good old fashioned supply and demand”.
Inflation outlook has shifted in 2021
James Burns, co-manager of Smith & Williamson’s MPS, notes that inflation was effectively off the table for much of 2020 as the impact of the pandemic – and the subsequent lockdowns across the globe – saw many drivers of inflation go into reverse.
While it tipped in the UK once more in November, with CPI inflation dropping to 0.3%, Burns says the outlook has shifted as we begin 2021.
“The key driver of this view is the outsized impact of policy, particularly the deployment of fiscal measures on top of the monetary stimulus that has been repeatedly used over the last decade,” he says.
He adds: “We believe tail-risks of significant inflation may also be tilted to the upside, with the risk that policymakers are potentially building up more significant challenges in the longer-term and that the reaction function of central banks and governments might well be too slow.”
Set against this backdrop, the Smith & Williamson team believe gold and precious metal securities, while carrying some beta, should also provide some protection in challenging markets.
“While inflation was a consideration, gold is also a means of diversifying returns in this environment,” Burns says.
“BlackRock Gold & General has been introduced across the range and plays to our medium-term view that increased inflation is likely, which should benefit the gold price.”
See also: Smith & Williamson adds Blackrock gold fund to tackle inflation
Index-linked bonds look expensive
For investment manager Chris Rush, who works alongside Metcalfe at Iboss, any rise in inflation will be a first for him.
“I have heard a lot about inflation and I know a lot about the theory, but many in the industry – myself included – have not really lived through an inflationary environment,” he says. ‘With this in mind it is worth looking at what things have traditionally worked and what have traditionally not worked in such conditions.”
Rush argues that most experienced investors would point directly to areas such as index-linked bonds and other index-linked instruments as the areas that would do well in an inflationary environment. While he says this is true, he notes at present there is currently a hefty premium to pay to get access to such assets.
“There is also no yield and the capital is extremely volatile,” he adds. “However there are other ways to insulate your portfolio from inflationary pressures and this includes going down the duration route.
“For some time our fixed income position has been short duration meaning it should have little interest rate risk and therefore it should be more suitable to an inflationary shock generally.”
Iboss favour strategic bonds over sovereign funds
In addition Iboss has also made changes to its sovereign holdings, including reducing its Treasuries and gilt positions.
While underweight in sovereigns, Rush says within its fixed income positions the Iboss team has been recycling that holding into strategic bond mangers.
“We are looking for strategic bond managers with longer track records that have outperformed in multiple market conditions,” he says. “These managers have a wide range of assets they can pick from, including sovereigns and index linked bonds.
“If you look over history, whenever inflation appears it tends to appear suddenly, sharply and without much warning, so you need to have somebody who can resound to that relatively quickly outside of the short duration positions we already have. We would expect these managers to flex in and out of inflation-linked issuances or short-dated bonds as is necessary.”
EM debt, commodities and infrastructure look appealing
For Ryan Hughes, head of active portfolios at AJ Bell Investments, when it comes to dealing with inflation – which he describes as the second most talked about issue in investments right now, just behind bitcoin – the key is to ensure investors have sufficient diversification in their portfolios.
“It’s worth remembering that high levels of uncontrolled inflation is not good for just about any asset class,” he says. “If we assume a controlled higher than normal level of inflation, standard bonds are the obvious casualties given the lack of inflation proofing built into their returns. Therefore areas such as emerging market debt may become much more appealing than developed market debt given their strong growth and lower level of existing debt.”
Hughes adds that equities should hold some appeal, particularly those that have pricing power or have exposure to faster growth which, again, he says points to areas such as Asia and the emerging markets.
“The other key area is of course commodities which tend to do well in times of rising inflation and therefore mining stocks or gold itself should hold some appeal to give some inflation protection in a portfolio,” he says.
“Infrastructure is another that could be a sensible place to put some money given many of the operators have inflation guarantees built into their operating contracts with governments, while on a related theme, energy has historically done well in times of higher inflation but given the shift to renewable energy, that link may not be quite as strong going forwards.”
