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Analysis: Investments become “real” as fears of inflation affect the attractiveness of bonds

© Reuters. FILE PHOTO: An electric vehicle charging station operated by the ESB (Electricity Supply Board) is in use in Dublin


By Saikat Chatterjee and Thyagaraju Adinarayan

LONDON (Reuters) – Electric Vehicle Infrastructure, Prime Office and Industrial Metals – With inflation looming on the horizon, investors are reducing their exposure to bonds in favor of “real” assets.

While such investments tend to generate income and often appreciate in value, they are particularly valued as a shield against inflation that many economists expect to generate a return when economies recover from the pandemic.

This means that significant changes will be made for multi-asset portfolios in the traditional 60-40 lines. Treasury bonds, such as US Treasuries and German Bunds, typically made up part of an approximate 40% bond allocation – they provided income and acted as an anchor against the lucrative but volatile 60% equity component.

But with low yields, G7 government bonds offer neither substantial income nor much security in normal times when things get rough, and inflation could prove to be an even bigger headwind.

Guilhem Savry, head of $ 22 billion macro and dynamic allocation, wealth manager Unigestion, has cut bond exposure to its lowest level since October 2019, favoring energy, industrial metals and commodity-linked currencies instead.

“The reversal in bond yields this year is the determining factor for the 60-40 portfolio,” he said.

“We believe that inflation will be much more sustainable than the (US) Federal Reserve thinks. The uncertainty about owning fixed income assets has increased sharply.”

Inflation is undermining the value of future bond coupon payments, and fears of a revival resulted in a 5% loss in the first three months of the year, the worst quarter since 1987, according to Refinitiv data.

It was also the first quarter in more than two years that a 60:40 portfolio lagged behind more flexible strategies, according to fund tracker Morningstar.

Those who stick to the 60:40 model will earn less than 2% on an annual basis over the next 20 years. Swiss credit (SIX 🙂 warns, a third of what has been generated in the last 20 years.

“We’re reimagining the ’40’ and looking at what else you can own to generate and diversify income,” said Grace Peters, investment strategist at JP Morgan Private Bank.

Peters has increased exposure to building materials, which is expected to benefit from a $ 2 trillion U.S. infrastructure boost. She is also bullish about digital infrastructures, particularly 5G networks and electric vehicle (EV) charging stations, as well as private or unlisted assets like real estate, where she sees “a wider range of opportunities”.

The 4% to 6% annual return, comprised of rental income and capital appreciation, exceeds that of most G7 bonds, Peters said.

European funds are most likely to be interested in reducing their exposure to bonds, said Christian Gerlach, founding partner of boutique investment firm Gerlach Associates. While inflation remains slumbering in the eurozone, yields on two-thirds of the region’s government bonds are negative.


Real assets grew in popularity even before the government and central bank-related incentives associated with the pandemic raised inflation expectations. Consulting firm Willis Towers Watson (NASDAQ 🙂 estimates that pension fund allocation has fallen to 29% over the past 15 years, while “alternatives” have almost doubled to 23%.

By and large, however, they remain owned and account for only 5.5% of the assets of exchange-traded funds, according to data from Bank of America (NYSE :).

The bank’s strategist Michael Hartnett is one of the proponents of real assets. He believes a worldly tipping point has been reached for both inflation and interest rates to stop the 40-year bull market in bonds.

Valuations for real estate, commodities, infrastructure and collectibles are the lowest since 1925 compared to financial assets, Hartnett told clients, noting that US Treasuries were the most expensive compared to, say, diamond prices.

After all, there is a 73% correlation between their returns and inflation, which makes them “a very good hedge against rising inflation and interest rates in the coming years”.

Investors will continue to hold the G7’s liquid, highly secure bonds, useful as collateral, capital buffers, and defensive assets, with rising yields over time likely to restore some of their ability to function as portfolio ballast.

However, BofA’s latest monthly survey shows that investors are “very short” bonds compared to the record highs in commodity allocations. 93% of the respondents expect a record inflation in the next 12 months.

Graphic: Treasury returns https://fingfx.thomsonreuters.com/gfx/mkt/ygdpzuledvw/Treasury%20returns.JPG


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