Barbour said that infrastructure companies held many of these characteristics, pointing out for example that high commodity prices had driven European power prices to record highs in the current cycle. He added that quality companies with moderately high levels of debt, strong cash flows and interest cover were likely to benefit from higher inflation, because the real value of their outstanding debt was eroded.
Barbour wouldn’t find too much disagreement from David Iben, the chief investment officer of Tradewinds Global Investors (whose global equities fund recently became a standalone offer through Advance Asset Management) even though (unlike DWS) he’s a long-only manager with no infrastructure or agribusiness funds in the stable.
“We don’t like companies with 10,000 competitors that can’t pass costs through – we like oligopolistic things like railroads, utilities, farm equipment,” Iben said from his Los Angeles base last month. “Resources obviously do well in inflationary times, but you don’t have to be a believer in inflation to like buying five dollar’s worth of coal for $1, or $1000 of gold for $800”, he continued, referring to the currently depressed prices of some resources like copper, nickel and gold. “You’re buying a free call option that inflation will lead to higher prices.”
There are three reasons why traditional portfolio allocations can lead to sudden, large drawdowns, according to the chief executive of multi-asset house Mellon Capital Management, Charlie Jacklin.
One is that they tend to be overconcentrated in equities. The classic 60:40 portfolio split is anything but “balanced”, according to Jacklin, because the variance of equity returns ends up explaining 90 per cent of the variance in the entire portfolio, and that’s not good when inflation might be on its way back up.
For example between 1973 and 2007, the US experienced 16 years where the actual inflation rate was higher than the year before. The S&P 500 produced an average annual real return of -2.5 per cent during those years, while the Goldman Sachs Commodity Index delivered a handsome 26.4 per cent.
Inflation is much friendlier to shares – during the 19 years of decreasing inflation, stocks did 16.2 per cent while commodities lost 5.9 per cent. Jacklin’s other two reasons for balanced funds occasionally losing a lot of money are somewhat related – he believes they are underinvested in a sufficiently diverse range of global markets, and that they contain insufficient protection from inflation shocks. “If you think your home economy is entering an inflationary period, sending money offshore is a hedge because your home currency will tend to depreciate,” he says.