How will you respond to inflation? 

Across Mercer’s global client base, one topic has come to the fore over the summer months – inflation.

While most industry commentators are busy spelling out the root causes of these turbulent economic times, at Mercer, we’ve been focusing on what we can do to help our clients remain on course to meet their long-term objectives, and to understand what tools we have at our disposal to maintain progress towards investment goals.

Sharing our thoughts and findings at the recent Global Investment Forum (GIF) US, held in Boston, was central to this. We brought together a range of Mercer’s experts to discuss the current inflationary environment, and share our findings with clients and the broader financial community. As well as providing a learning experience for attendees, it was also a valuable opportunity for us to hear how our client base is set to respond to the risks and opportunities facing investors today.

My Mercer colleagues had already set the tempo of the event with a number of sessions exploring the why, when and how of this current inflationary cycle, and further sessions diving into the attributes of various asset classes and how they can be used to provide inflationary protection to portfolios.

My colleague Chris Canstein told GIF attendees about how he bought a brand-new truck after moving to the US, but inflationary pressures and rising fuel prices had dampened his road-tripping ambitions. He pointed to a more volatile inflationary environment necessitating a new approach to scenario analysis – one that accommodates shifting inflation risk and novel risk drivers. His advice? Diversify.

The obvious question is ‘where?’, but every investor has different objectives. There is no one-size-fits-all answer. Instead, understanding the available asset classes, in light of current geopolitical events, economic and market forces, and global trends is valuable, and an area we feel Mercer is well placed to guide clients on.

Jason Sookhoo is a senior investment consultant at Mercer. He pointed GIF attendees towards two headwinds facing fixed-income portfolios that simultaneously facilitate a transition to private debt –  inflation-eroding bond returns and rising rates negatively impacting returns due to duration and credit spreads. Sookhoo noted that private debt can help alleviate these risks as the floating rate component attached to private debt investments rises as market rates rise.

Travis Simon, CFA at Pavilion, a Mercer Practice, explained why gold is often called “the ultimate fear asset,” and has risen in value nine times in the last 15 equity market sell-offs. Currently, gold is relatively flat, while equities and some bonds are down double digits.

Next, Nick Barron, CFA, senior investment consultant, outlined how in the natural resources space, higher prices will ultimately benefit the natural resource producers over the long run. Exposure to this sector can help mitigate the long-term structural impact of inflation on a portfolio.

Ashley Holder, investment consultant noted the relationship between commodities and inflation, particularly in light of potential stagflationary shocks and constrained supply chains coinciding with further infrastructure spending globally.

“Futures contracts offer the most direct exposure to commodity prices and are the most direct exposure to inflation hedging characteristics,” she said. 

Liisa MacNicholas added her thoughts on infrastructure – the backbone of the economy. Infrastructure companies have built-in increases for inflation, such as long-term contracts with annual CPI-based increases, affording investors an attractive hedge against potential risks.

With all that in mind, where does that leave our clients when deciding which asset classes to invest in? The most popular asset class, based on a poll of attendees at the session, is infrastructure, owing to the fiscal structures in place to offset inflationary risks.

The next preference is private debt, an area we have seen increased asset flows and interest from our clients. Natural resources and commodity futures is next on the list of preferred asset class, with gold rounding off the list.

I also asked attendees if there are any asset classes they would not invest in. Only 1% of respondents reported that infrastructure is not in their plans. That is a clear indication of the popularity of the asset classes’ inflation-beating credentials.

Natural resources followed, with only 7% saying they will not invest in the asset class. Commodity futures (17%), private debt (20%) and gold (54%) completed the asset classes.

While there is a clear indication that some asset classes are more popular than others, the past three years have taught us that circumstances can change in an instant, making it vital that all investors consider their portfolio construction to ensure it can weather any inflationary storm.

^{1 Source: Refinitiv & Mercer Analysis. Standard and Poor’s 500 Index & Gold bullion price using quarterly data from 3/31/2006 – 12/31/2021.}