07 December, 2020

For us, long-term investors with objectives to achieve, inflation is always a key consideration. Even if returns look healthy or are outperforming a benchmark index, inflation can eat away at the overall value of a portfolio and leave you short of what you need.


So, with the unprecedented amounts of central bank-printed money swirling around the global financial system, should investors be seeking protection from a potential pick up in inflation?


The answer, like much at the moment, is not straightforward, but I was lucky enough to debate it earlier on this year with a panel of institutional investors at the FT's live digital Global Boardroom.


We all agreed that in the short term, deflation was the more pressing concern as the shock of the current crisis percolates through the system. Indeed, as I had mentioned on the panel, in the short term, inflation would be a triumph!


However, the real threat would come if inflation were to pick up – and investors who have failed to prepare for it may find themselves with an expensive mistake on their hands.


The road to inflation

This year, governments and central banks around the world have injected trillions of pounds, dollars, yen and euros into both financial markets and the physical economy to keep them afloat during the pandemic.


While this is in theory inflationary, as we saw during the last financial crisis, despite significant quantitative easing, inflation has stayed relatively low.


Fellow panellist Kerstin Hessius, CEO of AP3, said the lack of inflation was due to the money being injected into the system just replacing lost revenue, but as the leader of the €37bn [1] Third Swedish National Pension Fund, she is keenly aware of the threat that it will come back – with a vengeance. Other fellow panellist Peter Pereira Gray, CEO of the Investment Division at healthcare foundation The Wellcome Trust, said the investment committee for the almost £27bn fund[2] was concerned that a significant breakthrough with a vaccine could fire up inflation relatively rapidly – the economic threat would be mitigated, but the monetary measures would remain.


With the news that a range of vaccines are set to come online over the coming weeks and months, we are watching what happens carefully, spending significant time researching and analysing what the next few months may have in store, to ensure our clients’ portfolios are prepared to face it.

As a long-term investor, with a dedicated focus on funding vital healthcare research, Peter said the investment committee was brutally aware of the diminished purchasing power of a portfolio ravaged by inflation. This meant the committee always built in protection against it.


Just because it is not evident today, do not think inflation cannot spike – and endure – quickly, and once it takes hold of markets, it is very difficult to offset in a portfolio through investment returns alone.


The defences against inflation

The entire investment team and I are deeply mindful of how inflation can eat away at portfolio values and even before this unusual economic situation, have been laser-focused on incorporating inflation protection into our client portfolios.


Having “real assets” inside the portfolio will make sense as they spread holdings across a wide range of risk drivers to earn varied returns and shield against specific losses.


Additionally, many private market assets have a degree of inflation protection built into to loan and deal terms, meaning investors have an automatic hedge to at least part of their portfolio.


We have therefore built up significant dedicated resources in these markets to identify and execute opportunities as they arise. Having the nimbleness to respond to opportunities quickly is key to ensure investors can lock in the best possible outcome.


While for many investors, inflation has not been a major concern for some time, now is not the moment to forget about it. With financial markets and the global economy uncertain as we progress through the pandemic, there is no certainty inflation will not come back quickly.


We have seen market events impact investment portfolios in all types of ways over many years and we are here to help prepare our clients’ portfolios for whatever happens next.


[1] https://www.ap3.se/en/ap3-intern-organisationsforandring/

[2] https://www.ipe.com/news/wellcome-trust-warns-of-slowdown-after-69-return/10042946.article

Niall O’Sullivan

I would like to speak to a Mercer consultant