GLOBAL - The emerging markets and commodities boom along with the effects of the economic stimulus packages mean pension schemes have found themselves struggling to make sense of inflation expectations, a new report suggests.
‘Inflation Hedging for Institutional Investors', published by Clear Path Analysis with contributions from pension managers, trustees, corporate sponsors and asset managers in the UK, Europe and the US, examines how institutional investors should position asset allocation strategies for a high inflation scenario together with the investment strategy that will best protect against growing inflationary pressures.
In the report, Nicolas Tabardel, global head of inflation volatility at Deutsche Bank, considered whether there will be substantial amounts of volatility in the future: "We've become used to low and stable inflation in the last 20 years," he said. If you take a long term historical perspective, that's an exception. Over the next five to ten years inflation volatility will be much higher, which makes it more important to develop investment strategies to hedge that risk."
"In the UK we have demand for floors from pension schemes but we also have supply of caps, so that's the only market where caps are available in large size and are cheap. It seems that everybody wants to buy inflation caps, the only place where caps are cheap is the UK but nobody wants to buy them here."
Explaining the rationale of using inflation options he added: "Many of our clients are exposed to inflation risk and inflation volatility risk in one form or another. We see pension funds that have LPI (liability driven investment) liabilities; we see real estate investors receive LPI linked rent and we see bond investors buy TIPS (treasury inflation protected securities) and therefore hold inflation flows. Both of these are good reasons to use inflation options."
Threadneedle Investments head of commodities David Donora said commodities also remain an effective hedging strategy. "They have long been recognised as a credible hedge against inflation, especially unexpected inflation. Commodities continue to provide protection against inflation and its destructive effects, particularly as long as emerging markets growth remains robust and developed market governments continue to deploy unorthodox economic policies.
"Emerging markets growth is highly commodity-intensive owing to the need to build infrastructure and improve the living standards for nearly half the world's population, so this demand for commodities appears well entrenched. On the current path, the best case scenario is that there will be a slow, sustained decline in the value of the dollar. With commodity prices denominated in dollars, this means that the price of commodities will continue to climb.
"Looking forward, while the risk is that we have to contend with a more volatile world, commodities continue to provide a safe haven for capital preservation and remain an effective hedge against inflation."
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