Defensive Asset Allocation in an Ifl i E iInflationary ...€¦ · Presentation to the...
Transcript of Defensive Asset Allocation in an Ifl i E iInflationary ...€¦ · Presentation to the...
Presentation to the PortfolioConstruction Conference 2008
Defensive Asset Allocation in I fl i E ian Inflationary Environment
Doug HodgeManaging Director, Head of PIMCO Asia Pacific
This presentation contains the current opinions of the manager and such opinions are subject to change without notice This presentation has been distributed forThis presentation contains the current opinions of the manager and such opinions are subject to change without notice. This presentation has been distributed forinformational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product.Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this presentation may be reproduced in anyform, or referred to in any other publication, without express written permission of Pacific Investment Management Company LLC. ©2006, PIMCO.
Since the 1970’s, inflation has been in persistent declinedecline
30%
20%
25%
10%
15%
0%
5%
-5%Dec-71 Dec-76 Dec-81 Dec-86 Dec-91 Dec-96 Dec-01 Dec-06
Austrialian CPI % YOY US CPI % YOY UK CPI % YOY
Europe CPI % YOY Japan CPI % YOY Canada CPI % YOY
Central bank success in its inflation targeting or were there other factors involved?
The Fall of the Iron Curtain
Agrarian Reform by the Communist Party of ChinaChina
GDP Growth Rates are on the Decline
8.7 8.89
7.4
6.86.5
6.07
8
9
)
2006 Actual
2007 Actual
2008 Projected
5.3 5.3
4.0
2.9 2.94
5
6
Y G
row
th (
%)
2.9
2.2
1.5
2.42.0
1.2
2.92.6
1.8
1
2
3Yo
Y
0Latin
AmericaEM Asia Emerging
EuropeU.S. Japan Euroland
The PIMCO view: Global growth will remain robust despite a cyclical downturnThe PIMCO view: Global growth will remain robust despite a cyclical downturn in the U.S and other developed economies
Source: PIMCO, JP Morgan, Goldman Sachs
But Emerging Markets Have Picked up the Slack
EM Share of Global GDP (At Market Exchange Rates)
28
30
24
26
rcen
t (%
)
22
24
Pe
2093 94 95 96 97 98 99 00 01 02 03 04 05 06 07
Growth will be driven to a greater extent by emerging markets that are in the midst of a breakout development phase
Source: PIMCO, IMF
Leading to a Divergence in Current Account BalancesBalances
Global Current Account Balances
2.0
2.5
Industrialized Countries
Emerging & Other Developing Countries
1.0
1.5
d G
DP
(%
) Emerging & Other Developing Countries
0.0
0.5
ce
nt
of
Wo
rl
-1.0
-0.5
Pe
rc
-1.570 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 07
Source: PIMCO, IMF
Heeeeeere’s INFLATION!
The inflationary pressures we are witnessing inThe inflationary pressures we are witnessing in emerging markets are spilling over into developed economies.
Inflation pressures will spring from several sources;
– Commodity Price PressuresCommodity Price Pressures
– Rising wages in emerging economies
– Increased social spending in developedIncreased social spending in developed economies
– Depreciating developed currencies vs emerging currenciesemerging currencies
– Loose US monetary policy that may be inflationary globally
Why Should We Be Worried About Inflation?
Inflation has the effect of reducing the purchasing power of money, which is at odds with the long term goal of most investors
Over time, it can chip away at real savings and investment returns.
Inflation affects all aspects of the economy, from consumer spending, business investment and employment rates, to government programs, tax policies and interest rates
How can I Protect my Portfolio From Inflation?
Rather than think about an investment portfolio as a range of asset classes, investors should think about their portfolios as a set of inflation hedges.
Inflation hedges can be divided into three main buckets;
– Leading inflation hedges
– Contemporaneous inflation hedges
– Lagging inflation hedges
Effective Hedging requires a recognition of where we are in the inflation cycle, followed by an appropriate allocation to the corresponding hedge
Leading Inflation Hedges
Tend to perform in advance of inflation becoming visible in the broader economyTend to perform in advance of inflation becoming visible in the broader economy
Leading inflation hedges include commodities and equities
Over longer periods, equities have shown a negative correlation to inflation and can be especially hurt by unexpected inflation
US Equities & Inflation -0.25 Australian Equities & Inflation -0.11
Unlike equities, commodities show a positive correlation with inflation
Commodities (USD) & Inflation 0.33 Commodities (AUD) & Inflation 0.45
Australian Equities represented by the ASX 200. US Equities represented by S&P 500. Figures are based on 1 year returns compared to 1 year CPI figures for Australia and the US from 1992-2007. Commodities are represented by the DJAIG commodity index denominated in AUD and USD. Figures are based on rolling 1 year returns measured quarterly from 1992-2008.
Commodities Diversify Equity Risk and Hedge Inflationary DriversInflationary Drivers
Positively correlated to inflationPositively correlated to inflationPositively correlated to changesin rate of inflation
InflationHedging
Negatively correlated to equitiesNegatively correlated to bondsDiversification g y
Magnitude of returns comparable to equities (1970-2007)Volatility comparable to equities
ReturnPotential
Once inflation becomes visible, it is time to move assets away from leading hedges such as equities into contemporaneous inflation hedgesleading hedges, such as equities, into contemporaneous inflation hedges
Contemporaneous Inflation Hedges
C t h d t d t f i li ith i fl tiContemporaneous hedges tend to perform in-line with inflation
Examples of contemporaneous hedges include inflation Linked Bonds (ILBs) or CPI S t tCPI Swap contracts
Both strategies provide explicit inflation protection and preserve real purchasing Th diffi lt ith b th t t i i l k f l f it blpower. The difficulty with both strategies is a lack of supply of suitable
instruments and securities in Australia
Ho e er a high le el of correlation bet een A stralian and Global inflationHowever a high level of correlation between Australian and Global inflation means that investment in a portfolio of global ILBs offers a practical solution to hedging domestic inflation
ILBs Diversify the “Disinflationary Bias” of Traditional Fixed Income
Low Inflation High Inflation
Traditional Fixed Income
InflationInflationInflationInflation
Real YieldReal Yield
InflationInflation
Real YieldReal Yield
Couponpayment
CumulativeCumulative
Principal
CumulativeInflation Accruals
CumulativeInflation Accruals
I iti l P V lI iti l P V l
CumulativeInflation Accruals
CumulativeInflation Accruals
Initial Par ValueInitial Par Value Initial Par ValueInitial Par Value
Once the presence of inflation is well established, investors should look pto take advantage of government policy response
Lagging Inflation Hedges
Lagging hedges are centered in those assets that offer returns following boutsLagging hedges are centered in those assets that offer returns following bouts of inflation
In countries where the central bank uses monetary policy to combat inflationIn countries where the central bank uses monetary policy to combat inflation, cash or bank bills can offer the most basic form of inflation hedge
Other securities include Floating Rate Notes (FRNs)- where an interest marginOther securities include Floating Rate Notes (FRNs) where an interest margin is paid over the cash or bank bill rate- also offer a good, lagged, inflation hedge
In Australia this strategy is particularly effective considering that aside from oneIn Australia this strategy is particularly effective considering that aside from one brief period, the RBA have managed to maintain a real cash rate
Australia’s Inflation Experience…
Australian Inflation
14
19CPI YoY
9
14
cent
(p.a
)
4
Perc
-1
Jun-8
8
Jun-8
9
Jun-9
0
Jun-9
1
Jun-9
2
Jun-9
3
Jun-9
4
Jun-9
5
Jun-9
6
Jun-9
7
Jun-9
8
Jun-9
9
Jun-0
0
Jun-0
1
Jun-0
2
Jun-0
3
Jun-0
4
Jun-0
5
Jun-0
6
Jun-0
7
Jun-0
8
Source: PIMCO, Bloomberg
…and the RBA response
Australian Inflation
14
19 RBA Cash RateCPI YoY
9
14
cent
(p.a
)
4
Perc
-1
Jun-8
8
Jun-8
9
Jun-9
0
Jun-9
1
Jun-9
2
Jun-9
3
Jun-9
4
Jun-9
5
Jun-9
6
Jun-9
7
Jun-9
8
Jun-9
9
Jun-0
0
Jun-0
1
Jun-0
2
Jun-0
3
Jun-0
4
Jun-0
5
Jun-0
6
Jun-0
7
Jun-0
8
Add a margin for active management and cash plus strategies become compelling ways to achieve high real rates of return as well as a hedge against inflation in the current environment of elevated rates
Source: PIMCO, Bloomberg
inflation in the current environment of elevated rates.
Conclusion
ngH Best: Equities Best: CommoditiesH
igh/
Ris
in
O W
T H
q
Mixed: Commodities &Nominal Bonds
Worst: ILBs
Best: Commodities
Mixed: Equities & ILBs
Worst: Nominal Bonds
allin
gH
A L
G R
Worst: ILBs
Best: Nominal Bonds Best: ILBs & Cash Plus
Mixed: Commodities &
Low
/Fa
R E
A Mixed: Equities & ILBs
Worst: Commodities
Mixed: Commodities &Nominal Bonds
Worst: Equities
Low/Falling High/Rising
I N F L A T I O N
Questions
PIMCO Commodity Real Return Fund
The PIMCO Commodity Real Return Fund is designed forThe PIMCO Commodity Real Return Fund is designed for investors seeking commodity exposure complemented by a core fixed interest allocation
The fund uses derivatives linked to commodity indices to gain exposure to the asset classexposure to the asset class
The collateral backing the commodity index positions is g y pinvested in a wide range of fixed interest strategies
PIMCO Global Real Return Fund
The PIMCO Global Real Return Fund is designed forThe PIMCO Global Real Return Fund is designed for investors who recognise that their liabilities are often in real terms and wish to protect against a rise in inflation
The fund utilises PIMCO’s core global fixed interest strategy of seeking active investment returns whilst moderating riskof seeking active investment returns whilst moderating risk
The fund is benchmarked against the Lehman Brothers gGlobal inflation Linked Bond index and hedged into AUD
PIMCO Diversified Fixed Interest Fund
The PIMCO Diversified Fixed Interest Fund is designed forThe PIMCO Diversified Fixed Interest Fund is designed for investors who wish to have a broadly diversified exposure to both domestic and international fixed interest markets
The fund invests in a mix of government and semi government bonds, mortgages, corporate and emerginggovernment bonds, mortgages, corporate and emerging market debt
The Australian component of the fund is positioned to take advantage of the high cash rates currently on offer
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Address:
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Sydney, NSW 2000
Tel: 02-9279-1771
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Past performance is no guarantee of future results This article contains the current opinions of the author but not necessarily those ofPast performance is no guarantee of future results. This article contains the current opinions of the author but not necessarily those of the PIMCO Group and does not represent a recommendation of any particular security strategy, or investment product. The author’sopinions are subject to change without notice. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. This article is distributed for educational purposes and should not be considered as investment advice or an offer of any security for sale.
No part of this publication may be reproduced in any form, or referred to in any other publication, without express written permission.
Copyright 2008, PIMCO