Despite interest rate hikes, pension fund are facing the challenge of restructuring their portfolios with inflation risks in mind. Many are now focusing on segments that offer inflation protection.

Diversification in investments has failed in 2022, according to market experts. Large selloffs in stocks and bonds have moved in lockstep. See our report. This positive correlation is likely to continue and leads to shifts in asset allocation, Christian Trixl, CEO Amundi Switzerland, is convinced. Tangible assets, and private market investments, are therefore likely to see a greater influx. He bases this on the study "Pension funds: reorienting asset allocation in an inflation-fueled world", which was published by 'CREATE-Research' and Amundi, the largest European asset manager. It includes the results of a survey of 152 pension institutions from 17 countries with a total of 1.98 trillion euros in assets under management. According to the report, around one in two survey participants intend to increase real estate, infrastructure, and private debt allocations.

Majority of Institutional Investors Expect Stagflation

The study also reveals that 50% of survey participants expect a stagflation scenario with high inflation and low growth. 38% expect secular stagnation or a return to pre-Corona conditions with low growth, low inflation, low investment, growing inequality and stagnating wages. Only 12% expect a 'Roaring Twenties' scenario, in which price pressures from supply constraints ease noticeably and growth picks up due to productivity gains from innovation. "After a long era of cheap money and double-digit yields, the sharp rise in inflation to a 40-year high in the Western world marked a turning point," says survey director Professor Amin Rajan of CREATE-Research. He adds, "The critical question for pension institutions, therefore, is how to rebalance their portfolios in a world with structurally higher inflation, less accommodative central bank policies and greater geopolitical uncertainty."

Swiss pension funds are particularly exposed

Swiss pension funds are traditionally invested mainly in bonds and real estate and have comparatively low allocations in equities and alternative investments. "Currently, they are therefore confronted with numerous challenges with regard to their strategic and tactical orientation," Trixl knows. And he continues: "In line with the global results of our survey, we also see the need in Switzerland to adapt portfolios to a stagflation environment as well as the interest rate turnaround and to specifically look for higher-yielding assets."

Search for yield premiums likely to intensify

The search for yield premiums is likely to intensify, according to market experts, as major market movements can lead to very favorable valuations for some distressed assets. Only just 11% of survey participants believe that inflation will have a positive impact on their investment portfolio, while 59% expect negative effects. Looking ahead over the next three years, 59% also expect returns to be much lower than in the last decade. Overall, therefore, asset allocation now focuses on three objectives: adequate total return, inflation protection and capital preservation.

Private market investments receive more momentum

To protect against inflation, pension managers are now turning to real assets, especially real estate, and infrastructure (both 49%). "However, this is not without problems, as the capacity of such assets is limited and illiquidity restricts flexibility," warns Trixl. At the same time, institutional investors are focusing more on private market investments.

For example, around 80% of family offices from the UK, the US, Switzerland, Germany and the Nordic regions do so. They expect to increase allocations to the private debt asset class over the next two years. Almost one in ten (9%) even expect a sharp increase. They see residential real estate and specialized areas of corporate finance, such as commercial aviation, shipping, and trade receivables, as the most attractive sectors. That's according to a new survey of 100 senior investment managers and wealth managers working for family offices with a total of $98.4 billion in assets under management. The survey was conducted by the market research institute 'Pureprofile' on behalf of Aeon Investments, a London-based investment company specializing in credit.

Higher yields attract

The main reason for increased investment in the private debt investment market appears to be improved transparency. 71% of respondents highlight the attractiveness of transparency. Around 70% also point to the potential returns, which are better compared with traditional fixed-income investments.

In fact, Schroders, a global asset management firm, predicts a 9.3% return on global equities over the next ten years - and even a 9.7% return on private equity.