Analysis: Investments get "real" as inflation fears dim appeal of bonds

JPEL Private Equity

08/04/2021 12:27

By Saikat Chatterjee and Thyagaraju Adinarayan
    LONDON, April 8 (Reuters) - Electric vehicle infrastructure,
top-end offices and industrial metals - with a resurgence in
inflation seemingly on the horizon, investors are slashing their
exposure to bonds in favour of "real" assets. 
    While such investments tend to generate income and often
appreciate in value, they are particularly prized as a shield
against inflation, which many economists expect will make a
return as economies recover from the pandemic. 
    That means major changes for multi-asset portfolios run
along traditional 60-40 lines. Sovereign debt such as U.S.
Treasuries and German Bunds has typically accounted for part of
a rough 40% bond allocation - providing an income and acting as
an anchor against the lucrative but volatile 60% equity
component. 
    But with rock-bottom yields, G7 sovereign debt is offering 
neither substantial income in normal times nor much safety when
things turn rough, and inflation may prove an even bigger
headwind. 
    Guilhem Savry, head of macro and dynamic allocation at $22
billion asset manager Unigestion, has slashed bond exposure to
nearly the lowest since October 2019, instead favouring energy,
industrial metals and commodity-linked currencies.
    "The reversal of bond yields this year is the game changer
for the 60-40 portfolio," he said. 
    "We think inflation will be much more sustainable than the
(U.S) Federal Reserve thinks. The uncertainty for owning fixed
income assets has increased sharply."
    Inflation erodes the value of future bond coupon payments
and fears of a pick up in the measure drove U.S. 10-year
Treasuries to a 5% loss in the first three months of the year,
their worst quarter since 1987, according to Refinitiv data.    
                            
    It was also the first quarter in more than two years that a
60:40 portfolio underperformed more flexible strategies,
according to fund tracker Morningstar.
    Those sticking to 60:40 models will earn less than 2% on an
annualised basis in the next 20 years, Credit Suisse warns, a
third of what was generated in the last 20 years.
    "We're re-imagining the '40', looking at what else can you
own to provide income and diversify," said Grace Peters,
investment strategist at J.P. Morgan Private Bank.
    Peters has added exposure to construction materials, which
are set to benefit from a $2 trillion U.S. infrastructure push.
She is bullish too on digital infrastructure, particularly 5G
networks and electric vehicle (EV) charging stations, and
private, or unlisted assets, such as real estate, where she sees
"a broader sweep of opportunities".
    Annual returns of 4%-6%, comprising rental income and
capital appreciation, exceed those of most G7 bonds, Peters
said.
    European funds are the most keen to cut their exposure to
bonds, said Christian Gerlach, a founding partner at boutique
investment firm Gerlach Associates. While euro zone inflation
remains dormant, yields on two-thirds of the region's sovereign
bonds are negative.
    
    CHEAP ALTERNATIVES
    Real assets were gaining in popularity even before
pandemic-linked government and central bank stimulus raised
inflation expectations. Consultancy Willis Towers Watson
estimates pension funds' bond allocations fell to 29% over the
past 15 years, while "alternatives" nearly doubled to 23%.
    But broadly they remain under-owned, comprising just 5.5% of
exchange traded funds' assets, Bank of America data shows.
    The bank's strategist Michael Hartnett is among those making
the case for real assets, believing a secular turning point for
both inflation & interest rates has arrived to halt the 40-year
bull market in bonds.
    Valuations for property, commodities, infrastructure and
collectibles are the lowest since 1925 relative to financial
assets, Hartnett told clients, noting U.S. Treasuries were at
their most expensive relative to, for example, diamond prices.
    Finally, there is a 73% correlation between their returns
and inflation, he said, making them "a very good hedge against
rising inflation and interest rates in coming years".
    Investors will continue to hold the liquid, ultra-safe bonds
issued by G7 countries, which are useful as collateral, capital
buffers and defensive assets, with rising yields over time
likely restore some of their ability to act as portfolio
"ballast".
    For now though, BofA's latest monthly survey shows investors
are "very short" bonds, versus record high commodity
allocations, with a record net 93% of those surveyed expecting
higher inflation in the coming 12 months. 
   
    
    

    <^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^
Treasury returns    https://tmsnrt.rs/3sJFnuk
    ^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^>
 (Reporting by Saikat Chatterjee and Thyagaraju Adinarayan;
editing by Sujata Rao, Kirsten Donovan)
 ((saikat.chatterjee@thomsonreuters.com; +44-20-7542-1713;
Reuters Messaging: saikat.chatterjee.reuters.com@reuters.net))