Years of accommodative monetary policy combined with ample liquidity from central banks, remnants of the global financial crisis of 2008, may be coming to a gradual end. We are arguably entering a transition period in the economic environment from one of low inflation, low interest rates backed by unconventional monetary policy (quantitative easing), to one of higher inflation and the potential of higher interest rates. Adding fuel to inflationary pressures has been a global pandemic where supply chains have been disrupted like never before, heightened geopolitical risks with the Russian invasion of Ukraine, known as the breadbasket of Europe, putting price pressures on everything from crude oil, wheat to sunflower oil, and globalisation, the accepted mantra for economic growth for decades, which is now under increased scrutiny with talk of a deglobalised world.

Periods of transition from a market perspective are always challenging. They are characterised by increased uncertainty and subsequently increased market volatility. In such environments it is a balancing act between defense and offence. In recent years, an offensive game has been a clear winner, however defense has become increasingly important. While we do not have a crystal ball on how high inflation will be and by how much interest rates may rise, the likely trend is up. With this in mind, considering assets that can assist in navigating a higher inflation environment is important. While there is no perfect hedge for inflation there are assets that can benefit from a higher inflation environment. Some of these include real assets such as infrastructure and property, commodities including gold, floating rate notes and inflation linked bonds.

Within Lonsec’s portfolio suite, we have built up our exposure to real assets for a number of years and have included assets such as gold as inflation risk was growing. Within fixed interest we diversified sovereign bond exposures with short-dated bonds and credit exposures. Given the nature of the Australian equity market, domestic investors will also have a structural exposure to commodities via the market. In such environments it is important not to swing the pendulum too far in terms of focusing solely on defense. In uncertain times and periods of market volatility, opportunities do arise. With this in mind we have retained a bias to growth assets and we think that the ability to generate positive active returns has increased and greater price dispersion in markets will provide more attractive entry points for quality assets that may have previously been out of reach due to excessive valuations.

The winds of change may be coming but markets are always evolving and reviewing your game plan is prudent.

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