The Quiet Revolution

As inflation hits multi-decade highs and interest rates look set to rise further, investors need to be aware of the risks of a more persistent inflationary environment and the potential for a period of lower economic growth.

Inflation in the US has risen to its highest level in more than four decades, according to the latest Consumer Price Index (CPI) report. The outlook could well deteriorate further as the war in Ukraine war and renewed Chinese lockdowns risk further disruption.

However, despite the current elevated levels, it’s important to note that long-term market expectations for inflation remain relatively anchored. The US 10-year breakeven rate –a closely-watched indicator of market inflation expectations over the next decade, representing the difference between the yields of 10-year nominal Treasuries and 10-year inflation-linked Treasuries - sits at around 3%. Clearly, one of the main dilemmas facing investors is gauging how far and how quickly the Federal Reserve is willing to go to combat inflation. This is not an easy task, given the central bank’s track record of engineering a “soft landing” is not very compelling.

With uncertainty and inflationary pressures elevated, investors need to be ready to adjust their portfolios accordingly. As we prepare ourselves for higher interest rates in the US and elsewhere, this could put pressure on competing asset classes, such as equities, and lead to bouts of volatility. However, this could also present tactical opportunities for long-term investors such as ourselves. We would argue that one of the best ways to protect value in the current environment is by investing in sustainable business models that are able to pass on costs to their clients.

Flexibility to look across a diverse investment universe

This sort of environment can be notoriously unfriendly to different asset classes at the same time. A traditional 60/40 approach will suffer if we enter a period where both bonds and equities fall, as we have seen already in some regions during the first quarter of 2022. At the same time, investors pinning their hopes on just a single asset class or a very narrow field of investments need to realise the heightened risks of this approach in an already uncertain environment.

Investors should not underestimate the importance of portfolio diversification during times like this. Effective diversification involves finding the right blend of assets to help to potentially keep price volatility low, or within a pre-specified range. This is where we believe multi-asset funds are particularly useful, as they typically offer a ‘one-stop shop’ solution for investors wishing to take a more hands-off approach. We think one of the best ways for investors to navigate these markets could be through a flexible, highly tactical multi-asset-led approach, and one that embraces the fast-moving and increasingly relevant world of sustainable investing.

The opportunities in investing sustainably

Over the past few years, both private and institutional investors have given increasing levels of credence to the social and environmental impact of their investments, alongside their financial prospects. This has taken place against a backdrop of uncertainty in global financial markets that has been driven in large part by pandemic, but also more recently by the recent rise in global inflationary pressure and heightened geopolitical risk.

The impact of the pandemic in terms of health challenges and the wider socio-economic impact cannot be understated, further serving to highlight global social inequality. This is why we think ‘impact investing’ has been highlighted repeatedly as one of the key ways to move forward.

Impact investing plays a key part in M&G’s range of sustainable multi asset funds, with allocations to impact assets ranging from 20 to 50%. These are positions in companies and institutions that intentionally aim to make a positive impact on some of the world’s most pressing environmental and social challenges. Impact investments can come from a range of asset classes including listed equities, green and social bonds, listed infrastructure or specialty funds. This focus on impact investments is combined with our belief that the best way to allocate between asset classes is in response to changes in valuations, which can often be rapid and widespread, and on understanding the behavioural and economic drivers of those valuations.

Where are we seeing opportunities?

Our funds are positioned to seek to take advantage of several long-term sustainability trends, including the transition to renewable energy, the emergence of the “circular economy” – where companies and consumers place greater emphasis on reusability and recyclability of products – and opportunities in social housing provision.

The graph below highlights the six positive impact areas we are targeting on M&G’s Sustainable Multi Asset team:

We look to achieve positive impactful investment through listed equities, green corporate and government bonds, supranational bonds, listed infrastructure and collective investment vehicles and other securities.

As countries look to enhance energy independence in the wake of heightened geopolitical tensions that have rattled energy markets, a focus on companies able to lead the transition to a renewable energy future makes perfect sense to us. Sitting within our ‘Climate Action’ and ‘Environmental Solutions’ positive impact areas, companies like Israeli renewable energy specialists SolarEdge Technologies look set to grow in importance. SolarEdge is a global leader in smart energy technology and offers a diversified product range for residential and commercial use.

Another recent addition to our funds has been Octopus Renewables Investment Trust, a developer and operator of diversified renewable energy assets, including onshore wind, solar and biomass. The company is one of Europe’s largest investors in solar power and generates all of its revenues from renewable energy.

Following the broad sell-off in local currency emerging market bonds in 2021, we have sought opportunities that gave us exposure to the asset class whilst meeting our sustainability/positive impact criteria. One such investment was a green bond issued by the government of Colombia. Proceeds from the bond issue will be divided into a range of categories, including sustainable water management, sustainable transport and biodiversity. The country has been reviewed positively by a reputable ESG ratings agency, and we believe Colombia’s green bond framework has robust governance procedures in place.

Get in touch

www.mandg.com/adviser  

advisorysales@mandg.co.uk