GRAHAM HARMAN: A lot of those assets are correlated highly to growth, not necessarily to inflation. But when you are looking at inflation-linked bonds, you’ve got that explicit link to inflation built into the accrual stream. JOHN COOMBE: Though it depends on how they calculate inflation, and whether they cheat on the calculations, and then change the basket of goods that go into the inflation calculation. You think you’re protected, but you’re not really because they changed it. Ask the Americans about it. GRAHAM HARMAN: Going back to the point about, dare we say it, a good news story within all of these different sources of crosssectional inflation. For heaven’s sake, what are commodities doing running two years into an economic expansion? They should be running eight years into an economic expansion. Is it one possible scenario that, you know, growth comes through, growth comes good, and we don’t have the disaster scenario, commodities are going down just when capacity use is tightening up, and we get a ‘Get Out of Jail’ card. It’s got to be one possibility. ipac’s JEFF ROGERS said it was important to define what one meant by ‘inflation’: There’s ‘big’ inflation, you know, double-digit inflation; and then there’s ‘uncomfortable’ inflation, outside the 3 per cent band, that requires a policy response. In that ‘uncomfortable’ scenario, certain equity strategies work as well as debt strategies, whereas in a ‘big’ inflation scenario, nothing’s going to work. SUSAN BUCKLEY: It doesn’t seem like it’s an environment where we’re going to be in a 1970s-type of world very soon. That sort of risk scenario is a long way down the track. But it does seem like an environment where the central banks are going to be lagging behind the inflation pressures coming out of the great global financial crisis. We see it with the US Federal Reserve – this time around, they’re likely to be much slower, rather than being preemptive. We’re getting a bit anxious that they’re going to be late, and the genie will be let out of the bottle, and all of a sudden we’re in this environment of 4-to-5 per cent inflation, which is very different to what we’ve experienced over the last 15 years.

JOHN COOMBE: Inflation at 4 or 5 per cent? I can’t picture it. Where’s all the wages pressure? SUSAN BUCKLEY: China. We’ve seen the minimum wage in China go from RMB400 a month in December 2000, to RMB1,100 a month now in Shanghai. The discussion turned to whether an active or passive approach was best when managing inflation-linked bonds and other securities SUSAN BUCKLEY: I think if you’ve got any passive global exposure at the moment, you need to be getting rid of that as fast as you can. Real yields in the US out to four years are negative – US four-year real yields at -0.6 per cent. That is expensive. If you’re holding short-end TIPS [Treasury Inflation Protected Securities], I think that’s the most expensive part of the bond market. Why? Because the Fed has conducted these unconventional policies, expanded its balance sheet, been buying bonds, buying TIPS, the Middle East investors are actually buying TIPS because they want inflation hedged. Everyone’s buying TIPS because they think it will protect you. Real yields are being driven to what I regard as unprecedented levels. Now, towards the10-year part of the curve, there is around 0.9 per cent real yield. Considering where rates will actually go, I’m really worried about real rates more than nominal rates, so that should be actively managed. The US is obviously a big part of a global inflation exposure, so I think that passive portfolios are quite vulnerable there, but generally our philosophy is that you want to manage your inflation protection and separate out that interest rate risk in your portfolio, and that requires some level of active management. We can debate the degree of active management required, but what you really want is that inflation exposure and to manage the interest rate risk through the cycle because at times, it’s going to hurt you badly when you want the most protection.

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