Who Are The Best Investment Managers for Inflation Hedging?

The Energy Transition from fossil to cleaner 'fuels' is now globally recognised as an imperative. The initial impetus has come from mass recognition on the need to tackle climate change, global warming and health externalities. And very recently, the realisation that energy security cannot be guaranteed by a reliance on Gas and Oil rich countries such as Russia. But investors are now asking whether the investment case still tenable?

The spillovers from the crisis between Russia and Ukraine are impacting the Energy Transition on two fronts:

- The rise in commodity prices whose levels are expected to remain elevated for much longer.

- A simultaneous rush by countries dependent on Russia for Oil and/or Gas to redraw their trading partners and enhance domestic energy supply.

Together, these two factors are driving the demand for the core inputs into the energy transition process even higher. Namely, the extraction, production and processing of metals. required to make the move. There is a problem of Greenflation.

The question on investors minds is whether these short term bottlenecks can be solved with long term patient capital investment. And if so, how, where, and via which asset classes. Ironically, the Energy Transition has become more urgent as a result of the Russia-Ukraine crisis. And the elevated price that needs to be paid remains more attractive than the alternative. Looking at search queries for 'Energy Transition' across all asset class research feeds inside RFPnetworks, t seems that the search for opportunities has only just begun.

Professional Investors have recently been rotating their portfolios based on the view that inflation is not going away soon. But is this a given?

Looking at headline CPI alone does not tell the whole picture. Digging into the US core CPI excluding food and energy costs, the 'other' drivers of inflation recorded a mediocre 0.3% increase in March in the US - the slowest pace in 6 months.

The world has had time to re-group and re-plan. And as such, the 'other' factors driving inflation - tight labour markets, supply-chain disruption and pent-up demand for a return to normal living - are resulting in a re-normalisation that supports the 'transient is back' argument.

Fixed Income Allocations

Fixed income investors are facing two cold fronts: A trifecta of tightening liquidity, slowing growth and high inflation; and sharply rising sovereign, investment grade and high yield bond yields. There has been nowhere to hide in traditional fixed income. The question being discussed with asset managers now is, what should we do?

Thus far, the knee-jerk reaction has been to reduce duration even as far as cash-plus, and shift to floating rate notes. But the majority of investment grade and high yield bond managers tow the line that at current yields, rate risk has been priced in, and spread risk has a sufficient cushion.

Their answer to the question "how do you invest in bonds when interest rates are rising" is "At these yields, does running a duration mismatch against your strategic allocation make sense?".

But there is a second answer coming from the doom camp, who believe the troubles are not yet over. And at the extreme, we have entered into a new regime for fixed income that can no longer rely on the support of central banks.

The answer stemming from this second camp is that unconstrained absolute return strategies are the way to go. Their view is that active management can deliver the necessary alpha if given sufficient flexibility across countries, duration, sector, securities and currency selection.

German Producer Price Inflation Soared 25.9% y/y in February 2022 suggesting we are moving from transitory to permanent to stagflation. Inflation does not look as though it has yet peaked and there could be worse to come. How will central banks respond?

View all economists reactions to the latest European inflation statistics inside RFPnetworks.