How multi-asset managers are combating inflation

Globally, economies and consumers are feeling the effects of the energy crisis, the war in Ukraine, supply shortages and price inflation.

But while central banks raise rates in a bid to dampen inflation's steady climb, and while those rates lead to potentially higher interest on cash savings accounts, investors are still generally concerned about the effect of inflation on their portfolios.

Aviva Investors's multi-asset fund manager Guillaume Paillat states that, in a high-inflation environment, multi-asset diversification is "harder to achieve, given the rise in the equity/bond correlation, challenging the traditional role of fixed income duration as a diversifier".

Inflation shock came as a result of a series of events.Hinesh Patel, Quilter Investors

So how are multi-asset fund managers structuring portfolios in a high-inflation environment?

Skewing portfolios towards sustainable companies, going underweight durations in bond allocations and maintaining a bias towards quality growth are a few of the ways that some multi-asset managers are shoring up funds. 

Hinesh Patel, portfolio manager at Quilter Investors, says the team had already been continuing to focus on quality companies with pricing power in equities and being underweight duration in bond allocations – particularly given ongoing interest rate changes.

For J Stern & Co's partner Jean-Yves Chereau, managing short-duration exposures makes a lot of sense right now. 

He says: "We are managing the mix of securities that are less sensitive to interest rates – for example, within fixed income [looking at] higher-yielding corporate bonds, with short duration.

"We are also looking at securities like equities, which have some sensitivity to higher rates, but whose fundamentals are very strong, whatever the economic environment, and which have the pricing power to offset the negative effects of higher prices while pushing through higher prices for their products and services."

Multi-asset manager Ben Seager-Scott works for Evelyn, which is often at the front line dealing with the investing public.

He says that mostly, multi-asset fund managers are doing enough to structure portfolios against a high-inflation environment – including Evelyn's own range. 

Seager-Scott says: "To an extent, it depends what you mean by a high-inflation environment – inflation is currently run at exceptionally high levels, which has driven an initial shock reaction from markets.

"For investing, however, it is future inflation and expectations of inflation, that is more pertinent, so it depends what inflationary environment you are looking to manage for in the future."

Diversify, diversify, diversify

What about alternatives or finding assets that have less correlation to each other?

Chereau comments: "The addition of non-correlated securities or investment opportunities also allows for the portfolio to have a lower volatility than would be the case in times of stress."

Paillat states that, in the context of soaring inflation, managers "need to work harder to build resilient portfolios by using further diversifiers".

Aviva favours: 

• International investing, to limit the risk of country-specific shocks (even in the home market).
• Cash as a buffer against volatility, which enables advantage to be taken of emerging opportunities. 
• Commodities, particularly gold, which will be less sensitive to an economic slowdown and may provide some inflation hedging benefit if central banks fail to keep pace with their tightening. 
• Absolute return strategies that are equipped to capture macro opportunities in falling and rising asset markets. 
• Active management in general, as asset class specialists have more opportunities to exploit. 

James Penny, chief investment officer at TAM Asset Management, says inflation-protected assets are forming the mainstay of defensive asset allocations.

He says: "Mainly infrastructure, real assets, treasury inflation-protected securities, linkers and dividend payers are looking appropriate.

"With the volatility on offer, there remains non-inflation plays that can also add protection, such as option derivatives and precious metals. These give an added layer of optionality compared to just pursuing inflation-protected investments.

"There will also come a time when inflation gives in to the forces being put on it by central banks and consumer sentiment, at which point a manager’s ability to pivot into longer-term opportunities will remain key."

Future-gazing

But Penny adds: "The challenge remains, when guiding ones hand on how much protection to overlay into the portfolio, in assessing how high inflation goes and how long it persists."

However, as the year progresses, Patel says the UK is on the "cusp of seeing the ‘high-inflation environment' move into the rear-view mirror".

Patel explains: "Inflation shock came as a result of a series of events, including the shift between economic shutdown to reopening, supply constraints, fiscal bonanza and the war-induced energy crisis, all of which – with the exception of energy and some raw materials – are now dissipating.

It depends what inflationary environment you are looking to manage for in the future.Ben Seager-Scott, Evelyn Partners

"Monetary aggregates, business confidence and consumers’ purchasing ability are all in a downward trend.

"With growth becoming scarcer, we can expect a quality growth-bias to perform throughout 2023, and following a decade-long hiatus, fixed income is also becoming increasingly attractive."

Patel is not alone in thinking inflation will pull back in the near future. 

We are managing the mix of securities that are less sensitive to interest rates. Jean-Yves Chereau, J Stern & Co

Seager-Scott says: "Currently, market expectations point to inflation peaking in the coming months and then falling back down to a level that is probably higher than we’ve had over the last decade, but below the damagingly-high levels we’re currently seeing.

"If you think we will be in a moderately inflationary world, then equities in aggregate are generally reasonably well able to pass through that inflation and can continue to perform, while fixed income is generally priced for such an environment (though zombie companies will likely come under great pressure)."

If, however, you think that inflation will stay extremely high, then even equity markets are likely to struggle from the shock to the discount rate, and fixed income would likely suffer further, he says. 

He adds: "But of course, if one is positioned for very high inflation and it doesn’t manifest, then performance can suffer that way too."

So the real answer to the question, 'How are multi-asset fund managers structuring portfolios in a high-inflation environment?' seems to be, 'With a watchful eye', given managers are always now expecting the unexpected. 

simoney.kyriakou@ft.com