Investors should to look to listed real assets to help protect against rising inflation threats according to Vince Childers, portfolio manager of the Cohen & Steers Diversified Real Assets Fund.
Rising inflation has never been far from the headlines in 2021 and last week’s news that UK inflation had surged to 2.1% in May, together with a more hawkish statement from the Federal Reserve regarding interest rate rises, suggest that in the short-term it is here to stay.
“The recovery in oil prices, supply chain disruptions and reopening economies suggest inflation could peak this year above 3% in the US and above 2% in Europe, before settling back in late 2021 and 2022,” said Childers.
But further out, he believes the market’s flat inflation expectations over the long run underestimate the potential impact of $30trn (£22trn, €25trn) in global fiscal and monetary stimulus and more inflation-tolerant central bank policies.
Childers added: “With inflation potentially underpriced, we believe the risks of inflation may be as high as they have ever been from a portfolio perspective, with bonds offering low yields and facing potential headwinds from rising long-term interest rates, and equity markets highly concentrated in high-duration large-cap growth stocks.”
For Childers, this creates an opportunity to allocate to asset classes that have historically performed well in inflationary environments and could therefore benefit from increasing investor demand.
So what are these real-assets? Cohen & Steers defines them as encompassing real estate securities, listed infrastructure, natural resource equities and commodities.
“Real assets have a history of helping portfolios during market conditions that tend to be challenging for both stocks and bonds, enhancing the diversification potential of traditional asset allocation mixes,” Childers said. “The most common of these market scenarios has been the occurrence of unexpected inflation.”
Whereas inflation surprises have historically had a mixed effect on stocks and bonds, Childers argued that these real assets have demonstrated strong, positive correlations, indicating a tendency to deliver above-average returns when inflation exceeds expectations.
“The persistence of surprisingly low inflation over the past decade has worked against real assets, contributing to their underperformance in recent years, particularly in commodities,” he said.
“However, with real assets now trading near multi-decade relative lows, we believe more attractive relative value, combined with increased inflation risk and improving fundamentals, has created a particularly compelling backdrop.”
With many real assets trading at attractive values relative to global equities, Childers believes 2021 is likely to be an “attractive vintage year” for allocating to real assets ahead of a potential turning point in inflation and interest rates.
But how are other managers guarding against inflation? While Smith & Williamson Investment Management’s Managed Portfolio Service (MPS) does not anticipate inflation “roaring ahead” as the British economy continues to reopen, it does expect inflation to remain more elevated than it has been in previous years.
“The outlook for conventional bonds is less attractive in this environment and there is a need to diversify to asset classes and funds that will perform better when inflation is higher,” said James Burns, co-manager of Smith & Williamson IM’s MPS.
The four assets Smith & Williamson is looking to to offer inflation protection are inflation-linked bonds, value equities, short duration bonds and gold.
“When we initially bought BlackRock Gold & General in the portfolios in December last year, it didn’t have an immediately beneficial impact,” said Burns. “However, we bought the fund with a longer-term view to diversify returns and provide some protection in challenging markets. This is a move that we expect will pay off as we transition into a more inflationary environment.”