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? 

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