mhp

Dear pension funds – inflation-linked bonds are not the only answer

David Oakley and Michael Mackenzie comment in the FT today that the return of inflation has unsettled financial markets.

Consumer prices rose 4 per cent in the UK over the last year according to this week’s new figures, double the targeted inflation rate. Increases in Germany and China have also raised eyebrows.

True to form, investors are responding by switching into inflation-linked debt. This is a favoured asset class for pension funds, but there are only so many of these bonds to go around. And investors do have other options. Word on the grapevine is that even better returns can be found elsewhere.

Here are some of the suggestions Oakley and Mackenzie came up with:

• Increasing exposure to commodities and food-related assets, the main causes of higher inflation. Investors are buying commodity-related stocks in mining and agriculture as well as wheat, coffee, cocoa and cotton.
• Buying exchange-traded funds, which are made up of a basket of the above commodities. ETFs are cheaper and more easily traded than the actual commodities themselves, which require storage and carry logistical issues.
• Leasing property for long periods to high-quality tenants such as supermarkets, where the rent goes up in line with inflation each year. Gives a safe tenant, protected return and the potential upside from rising real estate prices.
• Replacing higher yields from longer-dated fixed-rate government bonds with equivalent yields in shorter-dated corporate bonds. Some are saying inflation risk erodes the value of conventional government bonds making these more risky company bonds in an improving economic cycle. Their idea is that corporate bonds are likely to benefit from the recovery, so switch into those instead.