Inflation headaches for cautious investors

Transcription

1 Inflation headaches for cautious investors Dr. Richard Marwood UK Investment Manager October 2013

2 An issue increasingly being recognised Daily Mail, 26 th September

3 Suzi Quatro sums it up Daily Telegraph, September 9 th 2013: Suzi Quatro: 'Low rates stink - I want my money to earn for me' Fame & Fortune: Suzi Quatro may have sold 55 million records in a 50-year career but she feels the pain of low interest rates like any other saver. 2

4 Base rates and Inflation 3

5 Recent history Inflation controlled? IL certificates issued for retail investors 1981 First IL Gilt UK UK introduces RPIX inflation target 1997 Bank of England independence 2003 Target switched to CPI 2005 First 50 year issue Is the downward trend in inflation over? Source: Bloomberg and AXA IM 4

6 Inflation and debt usually come in pairs 15 UK US Consumer price inflation, y/y%, 11-yr MA 10 5 Napoleonic wars: deficit monetised US war of independence US civil war Fiscal monetisation Fiscal during WWII monetisation during WWI Volcker clamps down on inflation 0-5 2nd industrial revolution: productivity rebound; gold finds Fiscal monetisation during Vietnam War; oil shocks 1st industrial revolution: productivity-led deflation Great Depression Throughout history, large amounts of debt have been followed by inflation pressures Source: AXA IM & DB. 5

7 Characteristics of an inflation-linked bond Mechanism of a nominal bond Mechanism of an indexed bond Cash flows Coupon Coupon Coupon Coupon Principal Cash flows Coupon Coupon Coupon Coupon Principal Issuance Year Redemption Life span Issuance Year Redemption Life span Fixed Coupon Coupon adjusted for inflation (positive inflation) The difference between the nominal bond yield and an inflation-linked bond yield with the same maturity issued by the same government is called breakeven inflation. This gives an idea of the inflation rate that needs to be realised over the life of the bond for the linker to outperform the nominal bond 6 6

8 ILGs and the RPI 7

9 Negative Real Yields Central banks worldwide have driven down short-term rates to all time lows. In addition Quantitative Easing (the purchase of longer term bonds) has pushed down longer bond yields. Because of the Breakeven Inflation relationship between nominal and real yields, this has also driven down real yields so that in most major markets real yields have turned negative. A negative real yield implies that a buyer of inflation-linked bonds will receive a return that is less than inflation. However remember that a buyer of nominal bonds is also likely to receive a return lower than inflation. Indeed if realised inflation exceeds the breakeven inflation rate, the nominal bond will give a lower return than an inflation-linked bond. 8

10 Lessons from history Annualised Performance from 1900 to % p.a. 1.4% p.a. 1.0% p.a. Equities best for the long run, the cost is higher volatility. Source: Graph and quote taken from Credit Suisse Global Investment Returns Yearbook

11 Equity versus Bonds 10

12 Not necessarily re-rating 11

13 The sources of inflation Demand Pull Inflation An increase in demand, if supply does not adjust immediately, results in higher prices Cost Push Inflation An increase in input costs induces firms to raise their selling prices to maintain their profits. Inflation by costs can be imported : oil, raw materials Inflation expectations a self fulfilling prophecy Inflation expectations of economic agents also constitute an ingredient of inflation since they will adjust their behaviour according to the anticipations they make about the evolution of prices (companies pricing power) Inflation, a monetary phenomenon An increase in the quantity of money leads to a rise in the general price level Monetarist approach MV=PT 12

14 Summary There is no silver bullet Low risk assets do not currently offer positive real returns Index-linked bonds are the best hedge, but are fully valued Sensible approach is a diversified asset portfolio Equities to drive real returns; bonds to reduce overall portfolio volatility 13

15 Biography Richard Marwood Richard Marwood Senior Investment Manager AXA Investment Managers Richard began his investment career in 1996, training as a UK Equity Analyst, and has been managing portfolios since Richard graduated with a First Class Honours Degree in Mechanical Engineering from the University of Sheffield and a DPhil in Aerodynamics from Lincoln College, University of Oxford