Investors should brace for the possibility of “higher for longer” inflation and prepare their portfolios for this risk now, Fidelity multi-asset portfolio manager Ian Samson has warned. 
As inflation stubbornly persists in hovering around the 5% mark or higher in many global economies, Samson suggests the economy is at risk of entering a persistent inflationary environment.
“Inflation has historically proved very hard to tame,” he said.
“There is a material risk that we enter a period of high, or at least more volatile, inflation like we saw from the early 1970s until the late 1990s. Betting on a swift return to the low and stable inflation of the last two decades is not a historical inevitability.”
The implications of this potential inflationary landscape are profound for investors. Most importantly, Samson expects constant fear around inflation to create a positive correlation between government bonds and risky assets (similar to the situation in 2022), making ‘duration’ an ineffective hedge for portfolios.
Historical data echoes his sentiments. From the 1970s to the 1990s, a period of high inflation, a 50/50 equity/cash portfolio had a better risk-reward than a 50/50 equity/bonds portfolio.
Given this, Samson suggested six strategies for investors to potentially navigate a sustained period of high inflation.
Prioritise equities and low-duration credit
“The important thing is to take enough risk to beat inflation over time, while acknowledging that long duration assets may be challenged,” the Fidelity manager said.
This means investors should maintain exposure to stocks alongside low-duration credit options such as short-dated credit, floating rate bonds/loans or traditional credit with a duration hedge.
Tilt towards assets correlated with inflation
Samson recommended a strategic tilt towards areas that are strongly correlated with inflation pressures.
Renewables and infrastructure, which are influenced by the inflationary pressures of decarbonisation and fiscal spending, are prime examples. Similarly, healthcare, with its pricing power and link to the demographic mega-trend, can also prove inflationary.
Traditional inflation hedges like REITs and energy stocks, however, are less favourable due to the current stretched housing prices and the global emphasis on decarbonisation, he argued.
Invest in select commodities and miners
A higher-risk strategy for hedging against inflation is investing in commodities and miners set to benefit from demand mega-trends, according to Samson.
However, the commodities chosen should ideally have a negative correlation with markets and offer value relative to their marginal cost to avoid becoming a significant source of portfolio volatility.
“Copper may be a sweet spot, benefitting from the ongoing multi-year move to electric vehicles,” the manager added.
Adopt alternative portfolio defence strategies
In an environment of heightened uncertainty, alternative forms of portfolio defence can provide some buffer. Samson suggests the consideration of hedge funds or long volatility strategies as potential solutions.
Invest in inflation-protected bonds or inflation swaps
Instruments like inflation-protected bonds (TIPS) or inflation swaps can offer protection if inflation remains stubbornly high, the manager explained. Despite their significant sell-off as central banks moved to fight inflation, they now provide a positive real yield.
Be more tactical
Finally, Samson stresses the importance of being tactical. In a more volatile inflation environment, it is crucial to seek out countries that offer a relatively better inflation outlook. Emerging markets such as India, Indonesia, Brazil, and South Africa could present attractive debt and equity opportunities, he said.
The outlook for inflation remains uncertain,” Samson concluded. “Given this backdrop, investors should be proactively thinking about ways to position for a potential longer-term regime change in market, even if this does not ultimately come to fruition.”