MEDIA RELEASE: It is becoming an increasingly challenging environment to achieve investment return objectives, and the asset allocation strategies that have worked for the past decade are unlikely to continue to be successful for the next, according to Zenith Investment Partners CEO, David Wright.

He says inflationary pressures will continue to build as the global economy moves beyond COVID-19, and as markets reboot, and this will have a mixed impact on a number of different asset classes.

“We have seen inflation take off over the past 6-12 months. This lift in inflation and the prospect for much less friendly central bank action is impacting all markets.

“Investors will need to assess each asset class they invest in, in order to identify how an inflationary environment will affect it, and how the level of risk and return may be impacted.”

But Zenith Investment Partners head of asset allocation, Damien Hennessy, while cautious in the near term, says inflation, up to a point, can still be positive for equities.

“Over the long term, equities really only de-rate when broader inflation has been above 3-3.5 per cent. Despite current high rates of inflation, market-implied longer-term inflation expectations are in the 2.5-3 per cent range. Bond yields have not yet risen to levels that more seriously undermine equity valuations but clearly the risks are growing and that is why we are taking a slightly more cautious stance. The key question is whether central banks will be forced to take monetary policy settings above so-called neutral levels. Historically, that has been associated with major market drawdowns and recessions.”

“Longer term, there are some good reasons to expect Australian equities to perform quite solidly over the next 10 years, with the likelihood that Australian equities are also in a strong position to outperform compared to global equities.

“For well over a decade, Australian investors increased their exposure to offshore markets and that decision has paid off, with global equities returning 16.8 per cent versus 10.8 per cent for Australian equities over the past decade.

“There is no doubt global markets offer increased diversification and exposure to different markets and sectors not available locally. The Australian market underperformance is partly a result of some sector biases but these will be less important going forward.”

“The outlook for interest rates and inflation, for instance, will not be as advantageous for some of the high growth/ big tech US companies as it has been in the past. In addition, the valuation starting point for Australian equities is currently superior to that of US equities in particular,” Mr Hennessy says.

The situation for bond markets in this environment is mixed however, and fixed rate bond markets tend to be negatively impacted by an increased inflation environment.

Nevertheless, Andrew Yap, head of multi-asset and Australian fixed income at Zenith, says bonds will remain an important part of investor portfolios in 2022.

“Our return expectations for Australian bonds are pricing in multiple rate hikes in the latter half of this year, and we have definitely seen a move from some investors to reduce the weightings of fixed interest to the benefit of cash and some defensive alternative strategies.

“But bonds will always have a role in a portfolio given their diversification benefits and their safe-haven status. They also tend to be well supported in ‘flight to quality’ times, as has been the case recently with the escalating Ukraine/ Russia tensions.

“While it is true that rising rates are bad for fixed rate bonds, other factors need to be taken into consideration. There are segments of the fixed interest market that may benefit from rising rates such as floating rate credits (loans, contingent capital, RMBS).

“It is feasible that some segments of the credit market do outperform, particularly those able to pass on cost pressures to end consumers.

“In this environment there is also the opportunity for investors to take advantage of term premia – that is, where yield curves are steeply sloped, it creates opportunities to invest in longer-dated bonds and subsequently benefit from their positive carry.”