02.07.2013
By Terry Flanagan

Investors Look to Counteract Inflation Threat

Although the specter of rising inflation—and all of the dangers that this entails—feels a long way off to some, buy-side investors are beginning to plan investment strategies to counteract this threat.

With central banks around the world obsessive in their zeal to keep interest rates low since the financial crisis—in a bid to stimulate economic growth—sooner or later this approach is likely to kickstart a recovery of sorts and lead to rising inflation as embattled nations look to throw off their shackles.

Generally, bonds take a beating when inflation becomes a problem, while equities, too, can also struggle if inflation is sudden or unexpectedly rises to high levels.

Ricardo Arroja, chief investment officer, Pedro Arroja

Ricardo Arroja, chief investment officer, Pedro Arroja

“All of this build-up with monetary accommodation policies throughout the world will lead to inflation building up in the long term,” said Ricardo Arroja, chief investment officer of Pedro Arroja, a Portuguese investment manager based in Porto and author of a recently released book on the Portuguese economy.

“You just don’t know when, but it will happen. So in that sense, anticipating assets that tend to correlate with inflation will probably be the best investment strategy going forward.

“Obviously equities are a better bet than bonds just now. Although dividends themselves are not incredibly high. Going forward, equities and commodities, especially those that react more closely or closely follow inflation indices, will probably do best.”

This threat of inflation is particularly worrisome for bonds. Many investors have used the asset class as a safe haven following the financial crisis, but creeping inflation could trigger a big rise in bond yields.

“Perhaps the greatest risk in financial markets is the direction of government bond yields, particularly if they were to rise aggressively,” said Tom Becket, chief investment officer at Psigma Investment Management, an investment manager based in London.

“Inflationary pressures are currently becalmed, but we are yet to see what impact the hyperactive behavior of central bankers will have in the future.”

Talk of a building currency way is also adding to inflationary worries as inflation is often associated with currency depreciation.

“I do worry about the currency wars,” said Arroja at Pedro Arroja. “When everyone is trying to devalue their currency, not everyone will be able to do that at the same time.”

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