Pension fund portfolios are shifting amid fears of stagflation
In an environment of increased financial market dispersion, active management will re-emerge, while passive management will remain important for cost reasons in a world of low returns.
Central banks quickly raised interest rates in response to strong price pressures. Despite their efforts, inflation is likely to be persistent. This highlights the need for pension funds to build inflation-proof portfolios, according to a new report published today by CREATE-Research and Amundi, Europe’s largest asset manager.
The study is based on responses from 152 pension funds from 17 jurisdictions managing €1.98 trillion in assets. It aims to shed light on the behavior of these funds, which must adjust to the impact of inflationary pressures on their portfolios.
The specter of “stagflation” implies an environment of low productivity
When asked about the most likely scenario for the global economy post-pandemic, 50% of respondents subscribe to the “stagflation” scenario: inflation too high and growth too weak.
38% of respondents favor a “secular stagnation” scenario, i.e. a return to the pre-pandemic environment: weak growth, inflation, physical investment, stagnant real wages and rampant inequality.
It anticipates a typical Roaring Twenties scenario in which strong growth, spurred by innovation-related productivity growth of just 12%, significantly reduces price pressures caused by supply bottlenecks and keeps inflation low.
Professor Amin Rajan of CREATE-Research, who led the project, said: “After a long period of cheap money and double-digit income, the sharp rise in Western inflation to a 40-year high in 2022 is a turning point. The key question for pension funds is how to redesign their portfolios. Structurally, higher inflation, a less accommodative central bank politics and a world of greater geopolitical uncertainty.”
Increased correlations change the game
Diversification is not expected in 2022, when it is most needed amid simultaneous declines in equity and fixed income markets. The positive correlation between stocks and bonds is likely to continue and lead to changes in allocations.
The first notable development is reflected in the increasing attractiveness of inflation-protected assets, primarily in the private markets, with one in two survey respondents saying they are increasing their allocations to real estate and infrastructure.
The search for higher yield should also intensify as market turmoil creates opportunities in discounted assets. One survey participant believes so “Bond markets are likely to provide good buying opportunities with ‘fallen angels.’ » According to 58% of respondents, flexible portfolios and uninvested cash reserves will encourage dynamic investments that will redefine the traditional 60/40 approach.
As major markets become increasingly out of sync due to differing inflation forecasts, greater diversification across regions will be appropriate. 43% of pension funds plan to increase their weighting in developed markets, while 40% favor emerging markets. China’s rise as an economic superpower is becoming a major theme.
Finally, “value” investing will return to center stage. Given the high correlation between stocks and bonds, 42% of respondents believe that diversification based on different risk factors is becoming attractive again.
Monica Defend, director of the Amundi Institute, notes: “Monetary policy tightening and the risk of an economic downturn have very high volatility in financial markets, including traditional safe-haven assets. A traditional 60/40 portfolio should incorporate new features such as high structural inflation, less accommodative central banks, economic fragmentation and industrial transformation, value Long-term issues like chain reshaping and strategic autonomy are of real importance.”
Global stocks will drive portfolio growth
Only 11% of survey participants think that the impact of inflation on the investment portfolio will be positive, and 59% think that it will be negative. As for the return on assets over the next three years, 59% believe they will be much lower than in the last decade. As a result, asset allocation now has three categories, each with a different goal: decent total return, inflation protection, and capital preservation.
70% of respondents see global equities as a key driver of portfolio growth and an asset class that will provide a decent total return (as long as inflation stays above 5%).
To protect against inflation, funds are shifted to real estate in private markets, especially real estate (49%) and infrastructure (49%). However, this is not without its problems, given the limited capacity of these assets and their inherent liquidity, which reduces portfolio flexibility.
Half of respondents (44%) prefer US Treasuries as a hedge against risky assets, followed by European Treasuries (40%) and Chinese Treasuries (36%).
Thematic funds benefit from going back to basics
The prospect of a global recession and the gradual withdrawal of liquidity by central banks make the search for predictable sources of value creation even more important. This study sheds light on changing sectors influenced by global trends resulting in a shift in business models, disruptive innovations and major restructuring of public policies. 46% of survey participants believe that thematic investing will be largely and 35% somewhat superior in the post-Covid world. As a result, 60% of them increase their allocation to thematic funds. Environmental, social and governance issues topped the list and were favored by 76% of respondents. Other topics to consider include health and wellness technology (50%), biotechnology (32%), and aging populations.
Active and passive complement each other
After more than a decade of strength, passive management appears to have retained its appeal for pension funds in current market volatility, particularly in terms of costs (86%), liquidity and hedging (56%) and as a means of diversification across sectors. the face of desynchronized world markets (49%).
However, as rates rise and monetary policy tightens, pension funds believe the environment could become more conducive to active management.
While respondents are more aware of the downsides of passive investing and believe it is too tied to yesterday’s winners, 52% believe active and passive management complement each other in a diversified portfolio.
For the future, 29% plan to increase their passive deductions, 16% plan to reduce them, and the remaining 55% plan to keep them as they are.
