While taming high inflation will likely lead to a soft landing, the risk of deep recession means it’s time to build balanced portfolios for all weathers.
When it comes to inflation, the horse has clearly bolted. UK consumer price inflation reached a 40-year high of 9.1% in May and the Bank of England (BoE) projects that it will rise above 11% this year before starting to subside. The BoE is now urgently tightening monetary policy but faces the challenge of judging just how much is enough.
To weather this highly uncertain environment, we believe that investors should balance portfolios with true diversification in mind across traditional growth assets, defensive strategies and real assets. This includes making full use of the alternative diversifiers available today, as well as looking to areas of emerging value that offer opportunities to de-risk defined benefit pension portfolios.
But before considering portfolio construction, it’s important to understand the following factors that are driving inflation, as well as whether this is temporary or could persist.
There remains a risk of stagflation or deeper recession in a replay of the high inflation and low growth of the 1970s. Gilt yields have already risen sharply in response to higher inflation after their multi-decade decline, while the US stock market and others have fallen by at least 20% – the definition of a bear market.
Against that background, we believe that defined benefit pension funds and other institutional investors should construct portfolios that can weather all conditions by diversifying across four building blocks:
What’s clear is that doing nothing in the context of fragile economies is not a wise option.
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