Global economies are entering a rising inflation phase which hasn’t happened for decades; but WTW expects the inflation rate to be “fairly contained” over the next three- to five-years, which is roughly in line with central bank expectations.
The UK investment consulting firm recommends investors allocate at least 10 to 20% of portfolios to inflation sensitive assets during this period, and “we believe this should be done in a more dynamic way, not as a long-term strategic asset allocation,” said Paul Colwell, WTW’s head of advisory portfolio group in Asia, during a recent press briefing.
Three factors should be considered when choosing a prime asset class in times of inflation: the sensitivity of an asset class to inflation, the reliability of the inflation hedging characteristics, and its degree of opportunity cost or the direct financial implications of that to a multi asset portfolio, he said.
Real assets, commodities and inflation-linked securities are expected to do well in both a “disruptive” and a “benign” environment, according to Colwell.
In a disruptive environment, he thinks gold and inflation swaps are likely to prove resilient to high inflation, while some specific commodities such as oil and real assets may also do well.
Meanwhile, traditional assets such as bonds and equities are likely to suffer due to a rise in yields and discount rates. Among bond markets, WTW favours higher yielding markets such as China and Korea.
In a benign environment, hedge funds, sovereign credits and contractual cash flows are likely to provide stability and income, while government and risk-free bonds outside traditional safe havens are expected to do well in a lower inflation scenario, noted the asset manager.
Energy transition effects
While it is unclear whether the transition to green energy will be inflationary or disinflationary, the London-based firm thinks the change is going to bring more volatility to the global economy.
When evaluating a company’s risk to climate change, the firm recommends that investors model the impact on commodity prices, the volume of production, and the change in revenue under a business-as-usual circumstances and under a climate change transition.
Their analysis shows that companies in the green energy sector should outperform traditional companies, such as electric car companies which should do better than traditional car makers if economies continue to strive towards net zero carbon emisssions.
WTW also believes that there are opportunities in the food and agriculture, power and energy, transport, buildings, and carbon sinks investment themes, with most investment potential in the US, UK and Australia.
Although there is a perceived lack of opportunities in Asia, the situation will change in the next one to two years, said Jayne Bok, WTW’s head of investments in Asia.
“Governments in China, Japan, Korea, Singapore, Hong Kong have all come out with targets towards achieving zero carbon emissions,” she said.
To hedge risks from climate change, WTW expects to see the emergence of new indices and derivatives which takes a company’s value-at-risk under energy transition into account. It is expected that these will be the leading-edge products to mitigate and measure climate change risk in the next few years.