Among a slew of macro-economic factors, inflation will continue to weigh on pension fund investments as the world enters the Year of the Rabbit.
A sharp spike in US inflation to a 40-year high in 2022 changed the game for institutional investors after a protracted period of low interest rates and double-digit gains in financial markets.
For pension plans, with their long range horizons and multi-decade-stretching liabilities, an immediate concern will be whether central banks will gain any form of control over the current inflationary spiral and ensure that inflation expectations remain anchored to policy targets.
As central banks attempt to achieve the highly desired "soft landing" that simultaneously reduces the risks of inflation and a recession, the potential for policy errors seems to be huge, according to experts.
“The interesting dynamic is thinking about central bank monetary policy — if you want to get inflation under control, what does raising interest rates by another 50 or 100 basis points actually do?” a chief investment officer of a prominent fund manager told AsianInvestor.
Conventional wisdom states that central banks have the tools and the knowledge to control inflation, but even veteran central bankers are questioning that long-standing belief.
Treasury Secretary Janet Yellen, who was also previously chairperson of the Federal Reserve, acknowledged last year that the Fed failed to anticipate the trajectory of inflation in 2021 and thought that it only posed a small risk.
“Central banks have been profoundly shocked by inflation, and so the notion that they can control it seems very odd to me,” the CIO said.
Other investment experts have also voiced similar lack of confidence in central banks to tame inflation.
Consequently, the expectation is that stickiness of inflation will remain an enduring theme for pension funds who have been seriously grappling with the issue after energy prices began to climb in 2021. That, in turn, led to rising energy and commodity prices working their way into goods and services throughout 2022.
The typical longer-term investor defense against inflation is to allocate more money to return-seeking assets, but many pension funds might not have enough flexibility to expand such allocations.
Even rebalancing their portfolios towards more passive allocations may carry their own set of risks. With a potential recession on the horizon, stock values may decline before they rebound.
There is almost no guarantee that inflation will come down even in the event of recession. It is possible a supply-side shock like the Russian gas and oil ban takes time to resolve as energy alternatives are not immediately in place.
The Year of the Rabbit provides more unknowns for pension funds than solutions and, as mentioned, inflation is only one factor along with the likelihood of a prolonged recession, elevated interest rates and debt levels, accompanied by a protracted Russia-Ukraine conflict.
In these uncertain times, it is likely pension fund investors will gravitate towards several well-identified investment megatrends in search of tailwinds.
These trends include the pursuit of decarbonisation, new technology, sustainable living, and the growth in emerging and frontier markets..