By Dynamic Planner Investment Committee [Aug 2022]

Dynamic Planner’s Investment Services team and the independent members of the Investment Committee [IC] have been identifying the risks of rising inflation and interest rates for a considerable time, being actively discussed at the quarterly meetings and reflected in decisions taken. This quarter is no different.

As the IC met on 23 July 2022, it was prepared for the subsequent UK interest rate rise and remains confident that its capital market assumptions are valid in these market conditions. Following the rapid economic bounce back from Covid lockdowns, the IC had become increasingly concerned about the impact of rising inflation expectations taking hold. With UK inflation currently running at 9.4%, the highest level experienced for more than 40 years, it is understandably grabbing the headlines.

The corrosive impact of inflation on living standards and reduction in spending power of accumulated wealth should not be underestimated, even when at modest levels. So, what can be done when the Bank of England is warning of inflation reaching 13% and staying at ‘very elevated levels’ throughout much of next year, before eventually returning to its long term 2% target in 2024?

Interest rates are already on the rise, with the biggest UK increase in 27 years announced last month (the Bank of England base rate now stands at 1.75%). Similar measures to put up borrowing costs are happening elsewhere around the world, with the US Federal Reserve having hawkishly raised rates to a range of 2.25% to 2.5%, and the European Central Bank delivering its first interest rate hike in over a decade, taking the eurozone out of negative rates.

A tightrope for central banks

The current combination of stagnating economic growth and rising inflation, referred to as ‘stagflation’, is particularly troublesome for asset allocators. Tightening monetary policy to tackle stubbornly high inflation, at a time when the economy is already slowing, can be a very difficult tightrope for central banks to walk, if recession is to be avoided. This unwelcome scenario had been a risk of growing concern for the IC, even back when market consensus expected inflationary pressures to be temporary in nature.

Oversight of ex-ante and ex-post forecasts and scenario analysis are essential functions of the IC. Results from detailed stress-testing conducted last year showed that a drawn-out stagflationary environment would create the most serious challenge for the multi-asset portfolio benchmarks. This was mainly due to the potential impact of sharply rising interest rates on bond values and their increasing correlation with equities. The latter has been magnified as yields have been driven to rock-bottom levels, due to unprecedented monetary stimulus post the 2008/09 Financial Crisis.

So, what has the IC been doing?

Using long-term trend analysis and research sources, the strategic direction of travel of the asset allocation decisions taken by the IC over a number of years can be summarised below:

  1. Managed reduction in bond exposures
  2. Continuing global diversification trend
  3. Prudent increases in cash positions

The multi-asset benchmarks, which have been running since 2005, have experienced periods of considerable market stress, but these decisions have helped prove them to be extremely resilient and perform in line with our long-term expectations.

As we navigate these prevailing cross currents of acute economic and geo-political uncertainties, the IC will continue its laser focus on ensuring the benchmarks remain best positioned for long-term investors looking for protection of their wealth against both inflation and volatility. You will be hearing more from us again in early September, when we announce changes to the 2022/23 benchmarks following the annual review process.