This institutional-grade asset class can combat inflationary pressures

As the world emerges from the pandemic, economies around the world have re-opened, albeit with record levels of fiscal and monetary stimulus, higher production costs and a global supply chain that has been pushed to its limits. It’s no surprise that inflation expectations are the highest in almost a decade. Inflation should build steadily over the medium term and will usher in the new norm.

Revolution Asset Management’s chief investment officer, Bob Sahota says these inflationary pressures come from a range of factors that have converged to create a new inflationary era. He says, “From the demand distortions and supply dislocations associated with the COVID-19 pandemic, geopolitical risks, as well as monetary and fiscal tightening, these factors are expected to increase volatility across financial markets in 2022.”

According to Sahota, “the reality of higher inflation and interest rate hikes has prompted asset owners to review their current defensive fixed-income allocations and assess the level of risk protection required in order to earn the investment returns needed to meet their targets.”

The traditional income sources, such as fixed-rate bonds, just aren’t available anymore. Investors need to look to niche areas to find the same risk-return investment strategies. Sahota says, “strategies across private markets, in particular private debt, may be well equipped to deal with the ongoing market volatility and changes to interest rates. In periods of higher inflation, private debt can offer investors a level of protection – being a floating-rate asset class means the underlying yield increases as inflation and interest rates increase.”

The enduring capital nature of private debt and the ability to absorb and pass-on rising costs place this strategy as an actual beneficiary of inflation. He says, “But senior secured private debt can offer more than that. It’s a defensive allocation that can help to preserve capital and provide genuine diversification and yield, whether through the right sub-sectors of private debt or the underlying assets well-positioned to flourish during an inflationary environment.

“The Australian investable private debt universe is large, and we believe the most attractive sub-sectors include leveraged buyout and private company debt – in businesses with the brand and customer strength operating in non-cyclical industries; private and public asset-backed securities (ABS) such as floating-rate quality mortgages; and loans to stabilised commercial real estate assets with annual contracted rent.” Mr Sahota added.

The asset manager finishes by saying, “With a robust deal pipeline, deployment into 2022 is set to be strong. In private company and leverage buy-out loans, the M&A boom of 2021 drove three times the level of activity versus the prior year and 40% higher versus the five-year average, and with international borders reopening, this is expected to fuel activity in 2022.”

Revolution believes the outlook for private debt remains positive and focuses its attention on private ABS. In the current market, Revolution is witnessing significant growth, particularly in non-bank lending activity in Australia and New Zealand, which it says continues to provide attractive opportunities for its portfolio and helps quality non-bank lenders realise their growth plans.

The asset manager finishes by saying, “Allocating more to higher-yielding, floating-rate assets such as private debt could be one strategy to minimise interest-rate sensitivity of fixed-income portfolios and guard against inflation risk, while at the same time increasing and diversifying sources of return.”

Ishan Dan

Ishan is an experienced journalist covering The Inside Investor and The Insider Adviser publications.