Inflation is a problem for the first time in decades, and yields have risen rapidly after consistently falling for years. This challenging new environment warrants a review of investment approach for many pension schemes.
Pension schemes’ asset allocations are often skewed toward the assets which have outperformed in the previous pro-growth regime (i.e. equities and credit). These assets have underperformed most year-to-date and are typically risk inefficient investments if held alone.
It is crucial that portfolios are robustly diversified to best protect them in the scenarios most relevant to the plausible futures we see today (e.g. stagflation, or recession). To do this, schemes should focus investment of their return seeking assets in balanced multi-asset portfolios.
Where schemes do not outsource asset allocation, it may be attractive to explicitly increase exposure to assets sensitive to rising inflation (e.g. commodities, index linked bonds, etc.) to balance remaining exposure to growth-biased assets. This should not be seen as a “tactical” shift, fundamentally it would move most portfolios to being more strategically diversified. However, making this shift today may also be attractive from a timing perspective given the current balance of risks.