IN CONVERSATION

Fiduciaries and investors ‘divided’ over inflation

There is a fundamental disconnect emerging between fiduciaries, and their underlying ‘real’ investors, on whether deflation or inflation is the prevailing investment theme, according to political and policy consultant Pippa Malmgrem, who spoke with Michael Bailey about why the prevailing model of strategic asset allocation has to change.

The political and policy consultant to global investors, The Canonbury Group’s Pippa Malmgren, has just attended the annual central bankers’ summer retreat at Jackson Hole, Wyoming, where for the past seven years she has been one of a handful of ‘external’ delegates.

One of her most recent observations is while fiduciaries are tending to see and react to a deflationary environment, “real investors” like sovereign wealth funds and family offices are positioning for inflation in the longer term.

She recalls recent conversations with finance ministers, who ask her why investors continue to buy their treasury bonds at the current prices.

“My answer is: I don’t know, but it can’t last… yield curves have to steepen over time, capital will move away from bonds and the cost of capital has to change.”

Malmgren points to China as a great example of how short-term deflationary pressures would be overwhelmed in the longer run.

“Sure, the Chinese Government is currently throwing 60 per cent of GDP at fiscal stimulus which they know is inflationary, but they’re doing it to avoid social unrest… bigger picture they know nothing will tear apart the social fabric of China like inflation, it separates rich from poor. You can see it in their crackdown on property speculation and corruption, as Australia is well aware following recent negotiations with a certain iron ore company – they are fearful of commodity price rises.”

Malmgrem was speaking at a Sydney event for pension fund executives put on by Deutsche Asset Management, and shared a panel with the German manager’s global head of portfolio engineering and analytics, Paul Spence.

Speaking exclusively with www.top1000funds.com after the event, both were united in their view that the prevailing model of strategic asset allocation had to change.

Spence said that asset classes were still seen, incorrectly, as the drivers of portfolios, whereas the factors underlying them should be the primary consideration.

For instance, investors thought they were getting diversity by splitting listed and private equity, but both were heavily exposed to the equity risk premium, while corporate debt and equity were both beholden to credit spreads and interest rates.

Indeed, Spence pointed to spreads and interest rates, along with value/momentum, as three primary examples of the signals which should be driving a more dynamic form of portfolio construction.

Malmgrem echoed that “the era of set-and-forget”, epitomised by pension funds with investment committees that met on a monthly or less regular basis, was “over… you have to anticipate and recalibrate”.

While investors had become “difficult to shock” following the collapse of Lehman Brothers, and therefore another ‘all correlations to one’ crisis was unlikely, Malmgrem did believe that increased volatility was here to stay, as was an era of lower economic growth and less exuberant consumer demand.