The death of inflation has been greatly exaggerated. Its return will first scare, then maim, then ruin the traditional balanced portfolios have that served investors well for a generation. Investors need to prepare for a world of greater inflation volatility. And with it a monumental risk – bonds and equities falling in tandem.
A great fear stalks the land of asset management – the return of inflation. And, with it, the death of an investing paradigm: the dominance of a traditional balanced portfolio of 60% equities, 40% bonds. These 60:40 portfolios have been structured to provide a good level of long-term returns, but with a smooth ride; to date, they have been a successful construct.
Today, with bond yields now so low and inflation fears creeping in, investors are confronting the obvious concern. In short, are bonds still the low-risk, diversifying assets which their historical statistical characteristics suggest they are? And, if you’re feeling really jolly, you should re-examine the role of equities too. Shareholders are benefiting from receiving a historically-high proportion of stakeholders’ return. What’s more, that return to shareholders is being capitalised on very low interest rates. Both of these supports would probably be tested in an era of higher inflation. They will be further tested if, as seems likely, the political economy is tilted towards redistribution of wealth and income (resulting in lower margins).
Investors’ generic fear for portfolios today is that bond prices can’t rise much more and so they won’t be a good hedge in portfolios. This is overly simplistic.
First, it ignores the possibility of negative nominal interest rates, something we see as unlikely but not impossible. More important, it ignores the key question: what drives the bond-equity correlation, and what conditions will turn it positive again? Put simply: when will bonds stop providing an offset to equities in a portfolio?
The full version of this article was originally published in the Ruffer Review 2021.
Henry Maxey, CIO
Joined Ruffer in 1998 after graduating from Oxford University with a first class honours degree in economics and management. He became a CFA charterholder in 2003. He managed the LF Ruffer Total Return Fund and LF Ruffer Equity & General Fund between 2001 and 2006. He joined the Executive Committee in 2006 and became Chief Investment Officer in 2010. Between 2012 and 2017 he combined this role with that of Chief Executive. Following the company’s growth, he relinquished the CEO role in April 2017 to focus on leading Ruffer’s investment strategy.
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