There is a fundamental disconnect emerging between fiduciaries, and their underlying “real” investors, on whether deflation or inflation is the prevailing investment theme, according to The Canonbury Group’s Pippa Malmgrem. The political and policy consultant to global investors was speaking directly after attending the annual central bankers’ summer retreat at Jackson Hole, Wyoming, where for the past seven years Malmgren has been one of a handful of ‘external’ delegates. Malmgren noted that while fiduciaries were tending to see and react to a deflationary environment, “real investors” like sovereign wealth funds and family offices were positioning for inflation in the longer term.

She recalled recent conversations with finance ministers, who asked her why investors were continuing to buy their treasury bonds at the current prices. “My answer is: I don’t know, but it can’t last…yield curves have to steepen over time, capital will move away from bonds and the cost of capital has to change.” Malmgren pointed to China as a great example of how short-term deflationary pressures would be overwhelmed in the longer run. “Sure, the Chinese Government is currently throwing 60 per cent of GDP at fiscal stimulus which they know is inflationary, but they’re doing it to avoid social unrest… bigger picture they know nothing will tear apart the social fabric of China like inflation, it separates rich from poor.

You can see it in their crackdown on property speculation and corruption, as Australia is well aware following recent negotiations with a certain iron ore company – they are fearful of commodity price rises.” Malmgrem was speaking at a Sydney event for pension fund executives put on by Deutsche Asset Management. She shared a panel with the German manager’s global head of portfolio engineering and analytics, Paul Spence, and both were united in their view that the prevailing model of strategic asset allocation had to change.

Spence said that asset classes were still seen, incorrectly, as the drivers of portfolios, whereas the factors underlying them should be the primary consideration. For instance, investors thought they were getting diversity by splitting listed and private equity, but both were heavily exposed to the equity risk premium, while corporate debt and equity were both beholden to credit spreads and interest rates. Spence pointed to spreads and interest rates, along with value/momentum, as three primary examples of the signals which should be driving a more dynamic form of portfolio construction.