During 2021 there has been the largest drawdown in total returns on long-dated US treasury bonds in the last 40 years.
Talking to the Corporate Adviser Summit, Aviva Investors head of investment strategy and chief economist Michael Grady warned that pension schemes may have to rethink future asset allocation for balanced portfolios as a result of changing economic circumstances.
“If there had been a 20 per cent fall in equities then this would be front page news but this has not really received the same coverage at all.”
He pointed out that economic conditions were likely to be very different over the medium term. Over the past 30 years he said a balanced portfolio of 60 per cent equities and 40 per cent bonds has served many pension savers well, and since the dotcom bubbles bonds have typically provided negative correlation during periods when stock markets have fallen.
However, with inflationary pressures coming into economies across the globe he said this picture may look very different in future.
He pointed out that this 60/40 portfolio did not look quite as attractive during the early 70s when inflation was “running out of control”. However, he reassured delegates that he did not think the economy was heading back to the 70s.
The data he shared with the audience showed that while inflationary pressures may be present, economies across the globe were growing and not stagnating. He pointed out that when compared to the global financial crisis of 2009, recovery post Covid was happening twice as fast in the US and potentially up to four times faster in the Eurozone.
This Grady said was largely due to the impact of policy makers in response to the Covid crisis with “unprecedented fiscal support”. He added: “This is the first recession where aggregate household income rose in the US.” This is largely due to government action across the globe with initiatives like the furlough scheme in the UK and increases to unemployment benefits in the US.
There is, he added, “baked-in assumptions” that we will not be returning to austerity and the reduction of deficits that was seen after the financial crisis, and that monetary policy “will let economies run hotter”.
When it comes to asset allocation decisions, Grady said schemes were in a difficult position when it comes to looking at altertnatives. One option is to increase equity holdings but this would necessitate “very active risk management” strategies he said, such as direct hedging to reduce volatility and risk.
Other options may involve greater use of alternative investments such as real assets, commodities or alternative risk premia.
He added that while global demand and supply issues were driving inflation the UK had the additional impact of Brexit to deal with, but he pointed out that from an economic point of view the effects of this had been masked by ongoing Covid problems.
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