Pension funds should look to increase inflation hedging – AXA IM

Pension schemes should look to increase their inflation hedging before a “big inflation shock” hits the markets, according to AXA Investment Managers (AXA IM) head of sovereign, inflation and FX, Jonathan Baltora.

Speaking at a webinar hosted by AXA IM yesterday, 24 September, Baltora gave an overview of the current situation regarding inflation, noting that the entrance of China into the global economy and global trade has been the main source of disinflation up to now.

However, he explained that if something were to impact the price of food, such as the current African swine fever pandemic, which is fatal to pigs, then this could have an impact, but it will be a shock to the global economy that will eventually “spur inflation”.

“If you see more localism, less globalization, this is definitely the kind of shock that would spur inflation. We’re not there yet, but this is a risk more than ever in the past 30 years,” he explained.

As a result, he believes that investors should look to increase their inflation protection. Baltora said that at the moment there is “no rush” but there is an “interesting window of opportunity” for institutional investors.

“We’re not at the stage where inflation is going to blow through the roof, so there is no rush, but this is definitely the direction of travel, to increase inflation protection, because from a valuation perspective it is, in our view, relatively inexpensive to do so, and the steepness of the yield curve means that you’re still earning more interest than at the short end of the curve in nominal bonds.”

He noted that a lot of Dutch pension funds are buying long-term inflation-linked bonds, which allows them to hedge duration and inflation exposure at the same time. However, he believes investors should look at different asset classes to in order to build an inflation-proof asset allocation.

For example, he suggested gold, although noted that institutional investors are “less involved with gold” but the asset class is “well correlated with the level of real interest rates”.

“Then you could start an equity approach, looking at those companies that have some leverage over the consumers that can benefit from shortages and increase prices when the time is right,” Baltora stated. He also said being a landlord is another way to hedge inflation, noting that the Dutch Statistics Agency has reported an increase in rent due to inflation.

“I think if you want to hedge for inflation, definitely inflation-linked bonds and inflation swaps, to some extent, are the destination for the bond part of your portfolio, but you should have a diversified portfolio, and this is more an asset allocation exercise rather than a purely inflation-linked bond exercise,” Baltora stated.

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