The world has changed yet the industry- standard balanced fund configuration, where a move from 70:30 to 65:35 passes for a strategic shift, remains entrenched.
This will spell trouble for super funds as the period of disinflation almost certainly comes to an end, writes ROB PRUGUE. At the height of the credit crisis “contagion of fear”, investors were rightly assessing the threat of two secular inflationary environments: deflation/ depression; and rising inflation. If successful in averting the credit crisis, the Keynesian-like fiscal and monetary response of governments and central banks are likely to yield to some sort of inflationary pressures sometime down the road.
If the response isn’t successful, then the credit crisis has the potential to convert itself from an asset deflation into an economic one. Either way, disinflation is unlikely to last indefinitely. If correct, then the risk/return metrics used in many asset allocation models may eventually yield some disappointing results. Secular inflati onary cyc les Historically speaking, GDP and corporate profitability cycles generally last for five years.
There is typically one global recession every five years, with corporate profitability correlating with GDP swings. Underlying this five-year GDP profit cycle, however, lies an even deeper and longer lasting capital pricing cycle: inflation. Inflationary cycles generally span between fifteen to twenty years; thereby holding between threeto- four GDP profit cycles for every one inflationary cycle. Using simple boating analogy, the profit cycle would represent the speed to which the boat moves whilst the more secular inflation would represent the tide that lifts the boat up and down.
Economic theorists like Peter Bernstein and Keith Ambachtsheer have long argued the need to assess the influence on capital markets under different secular inflationary cycles. Although perhaps they’ve used different names in identifying these, the dates highlighted have not been too dissimilar. Essentially, there have been four secular inflationary cycles during the twentieth century (five if you include the artificial pricing period during the war years): Depression/ deflation (late 1920s and 30s); Benign inflation (1950s and half of 60s); Rising inflation (1970s and early 80s); and Disinflation (mid 1980s through to late 1990s).
The risk/reward metrics under these different secular inflationary cycles have varied significantly, both in nominal and real terms. Given the current debate as to where the inflationary cycle may be heading, we decided to re-examine Messrs. Bernstein and Ambachtsheer’s posit as to how asset class risk metrics vary over these four different inflationary periods. If they do, then what does this say to our current diversified asset class configuration? Is the standard balanced fund growth/defensive asset allocation of 60/40 a relic of the past?
