The question of whether the current trend of rising inflation is a transitory or permanent one is not trivial. It is forcing the institutional investor community to reflect on their long-term investment strategies. Investors have to review their current approaches and get ready to make significant changes if their views prove incorrect.
There are plenty of reasons to believe that inflation will return to the low levels of the past decades. As Stefan Gerlach, chief economist at EFG Bank points out in this issue’s Prospects 2022 section, often one-off price shocks can be misinterpreted as signs of a generalised trend of rising prices.
The secular forces that have acted as a drag on inflation over the past decades, including digital technology, globalisation and the ageing population, to name a few, are still very much alive.
Central banks are preparing to normalise monetary policy by raising interest rates, but in keeping with their price stability mandates, they should and will act to restrain any persistent and dangerous inflationary spiral.
However, investors must always keep in mind that it is extremely difficult to correctly predict macroeconomic events, much less the direction of long-term trends.
Just as it was hard to believe that interest rates would fall for several decades, eventually edging into negative territory, it is difficult to tell whether or not a regime change in terms of inflation is taking place.
Many experts, who believe that the current inflationary spike is transitory, conveniently state that the outlook for inflation will change if we see persistent inflationary pressures over the next few years.
Within this complicated scenario, investors know that they can be prepared for whatever comes. Perhaps, like never before in history, they have a range of asset allocation and hedging tools at their disposal to insulate their portfolio for the possible negative consequence of a period of high inflation and low growth.
But the key point is that investors do not act in isolation from the market.
An individual investor’s investment decisions has consequences beyond its portfolio, particularly when it comes to large, influential investors. In other words, investment behaviour driven by fear tends to breed fear.
To that extent, collective asset allocation decisions driven by a belief that inflation will rise or stay low can have different consequences. They could suppress or drive inflation higher, depending on the type of assets.
Pension funds, in particular, have, first and foremost, a duty to their members, therefore their decisions tend to be self-focused.
However, it is crucial for investors to be aware of their wider place in a system. Their focus on member outcomes should be combined with a concern for the health of the investment ecosystem.
For that reason, investors should not worry too much about being on the right side of the inflation debate, but continue to make investment decisions that show confidence in the financial system’s ability to support the global economy.
Carlo Svaluto Moreolo, Deputy Editor,