The global economy is facing a potential period of stagflation with persistently high inflation and slow growth, according to the chief investment officer of the $230 billion Australian Retirement Trust (ART), Ian Patrick.
“There is a very real possibility of a stagflationary environment,” he said in an interview with Investment Magazine.
Patrick, who was investment manager of Sunsuper before its merger with QSuper earlier this year to form Australia’s second largest superannuation fund ART, said investment managers were now faced with making decisions against a backdrop of persistently high inflation and the prospect of increasing interest rates and a potential recession.
“It’s a fascinating time to be investing,” he said. “There is now tension in the debate. Has inflation – or more importantly inflationary expectations which influence long term interest rates – peaked?”
“Or will we still see some upward movement in inflation and inflationary expectations and therefore interest rates?”
Rising rates hurt bonds
He said if interest rates were to continue to rise, investors could lose money by investing in bonds.
“It’s the classic portfolio decision – do I want to position myself for defensiveness now, even if I am a bit early, or are we only halfway through the movie [of rising interest rates]? I think we are probably closer to the end [of rising interest rates].”
Patrick said ART was not going to invest significantly more heavily into bonds because of its concerns about the prospects of stagflation but it was expanding its portfolio of bonds to a broader number of countries, beyond the US and Australia.
He said government bonds were now yielding around three per cent, which was a lot better than recent years. If the world were headed into a recession, these would be a good investment.
“If you were to see the typical response where government yields decline, bonds provide genuine protection. You are getting an absolute yield should a recession eventuate,” he said.
“You could make quite a strong case for those who haven’t had much by way of bonds to reweight towards government bonds.”
“We have moved so far in long rates since 2020 and we are staring at the prospect of a recession. The basic asset to defend in a recession is a bond.”
Patrick said he believed inflation, which is currently running at just over six per cent in Australia, could moderate to about four or five per cent. But he said it would be a lot harder to for it to get below four per cent.
He said there was a danger central banks could react in a heavy handed way to push inflation below three per cent which would “certainly bring on a recession”.
If they decided to take an easier approach and “tap on the brakes” inflation could “stick around for a bit longer”.
“Inflation is not great for a number of assets, particularly if we end up in a classic stagflation environment and growth is weak.”
Diversify asset base
He said his fund’s investment approach was to be diversified and to look for inflation resistant assets such as unlisted assets including infrastructure.
Patrick said he expected ART would continue to invest in big ticket deals such as its recent deal to take over the vehicle registration and licensing operations of Vic Roads, in a consortium with Aware Super and Macquarie Asset Management, and the agreement to invest $150 million into social housing projects in Queensland with QIC and the Queensland Government.
Patrick said the fund was prepared to do more deals with governments, responding to comments by the Federal Treasurer Jim Chalmers who called on super funds to sit down with government to look at big ticket investments in nation building projects such as renewable energy or social housing.
But he said these deals involved complex negotiations to ensure that super funds were not holding high development risks and could make investments in the best interests of their members.
He said this year’s merger of QSuper and Sunsuper to form the Australian Retirement Trust gave the combined group much more bargaining power when it came to being involved in big deals, particularly large unlisted assets.
It could also have a stronger presence at the table to ask for board seats with its investments as it did in the deal with Vic Roads.
“The combination of the funds brings a different set of opportunities to invest in. The most notable example is the recent deal we did with VicRoads. Had that been an investment which was just made by Sunsuper we probably wouldn’t have spoken for enough capital to get a board director in our own right.”
“We wouldn’t have had the same governance input and control. As a combined fund, we speak for a larger proportion of the equity capital.”
Being a larger fund also meant it could negotiate cheaper investment management fees from outside fund managers.
Patrick said bringing the investment management teams of the two funds together also provided synergy as “each team had strong capabilities in particular areas”.
“Almost instantaneously you get this new capability in terms of the combined team which will deliver value for members. We can do some things more cost effectively than we did before.”
ART is now seeing annual fund inflows of around $10 billion a year from member contributions and another $10 billion again from winning new business from financial advisers and taking over other funds to manage such as the Australia Post superannuation fund.
He said he also saw ART doing more complex, big ticket deals with investment managers like QIC, New York-based Global Infrastructure Partners and Canadian asset manager Brookfield.
Upping private credit
Patrick said he also saw ART becoming more involved in private credit including lending to big companies and for property developments.
But he said it was reducing the risk of these investments by diversification. “We do have meaningful exposures across the private debt universe, both in Australia and offshore. But the majority of it is offshore.”
“With most corporate debt, whether it is listed or private, you want meaningful diversification across your counterparties because of the risk of default, particularly in an economic downturn.”
“You never know exactly who the winner will be, so you want to diversify the risk of default.”
He said the private debt markets in the US and Europe were much deeper than those in Australia. “That is not to say we are not involved in private debt in Australia – we are.”
“But I would not support allocating all our private debt to Australia and to a limited number of corporates. If you did, you would be found wanting in terms of diversity.”