While various stimulus packages got the global economy through the short-term challenges of COVID-19, they were always going to cause difficulties in the medium term. Inflation has risen and recessions look likely, so how can investors respond effectively?
The global economic system appeared to cope with the COVID-19 pandemic and its associated lockdowns. Individual policymakers took different approaches to their economies, each of which had different impacts at a micro level and there were winners and losers throughout the process, but, broadly speaking, the wind kept filling the economic sails and countries kept moving forward.
Inflationary Risk
Keeping economies buoyant was economically and politically expedient in the short term, but it carried a significant medium-term inflationary risk. The complications created by the events in Ukraine have piled further pressure onto an already fragile structure and as we approach the final quarter of 2022, many countries face levels of inflation not seen since the 1990s.
There is a very real threat of a global recession in 2023. Traditionally, economic policymakers have used interest rates to bring down inflation, raising them to make it more attractive to hold money in the bank or invest in government bonds rather than keep spending.
Interest rates have been at historically low levels for the best part of a decade, so there is plenty of scope for them to rise and this is likely to have a significant impact on investment decisions.
Why is Inflation Important?
The aim of investment is to either create or preserve wealth, which means that during periods of high inflation, investors need to ensure that their portfolios work harder to stop value from being eroded. The challenge is that inflation impacts different asset classes in different ways.
Inflation has been very tightly controlled in the developed markets over the last couple of decades, so there is relatively little experience of dealing with it in the markets. Understanding how individual asset classes have responded to periods of high inflation can offer a good gauge for what might be expected to happen during what is set to be a very challenging couple of years.
How Should Investors React?
At the same time though, even if it doesn’t evolve into a full-blown recession, smaller companies struggle with cash flow during a downturn no matter how innovative their idea and flexible their setup. In many ways though, it is in the difficult times that ideas are tested, teams are forged and world-beating companies are built.
This makes investment during challenging times all the more important and can make the potential returns all the more tantalizing.
Making losses More Manageable
Most investors have experience with the 60/40 (equity/bond) portfolios but this asset allocation is struggling in 2022. As of August 2022, a balanced portfolio is down close to -15 percent in dollar. When the markets become challenging, it is no secret that diversifying an investment portfolio tends to help spread the risk and potentially make losses more manageable.
Asset managers such as the team at Petiole Asset Management tend to have access and for many years expertise in a wide array of asset classes in the private markets which can give them a broader view of potential investment opportunities to improve the risk-return profile of their whole portfolio.
Change, Flexibility and Transparency
The investment space has obviously changed significantly over the last 15 years, with new digital tools that offer a level of transparency and of reporting that would have been inconceivable a generation ago. These tools enable investors of all sizes to be far more inventive and flexible in their approach to their private asset portfolios.
In a lot of ways, investing is like sailing a yacht: with a little practice, most people can quite happily take a boat around a calm bay on a clear day with a light wind and get something positive from the experience. If conditions change though, the skies darken and the wind picks up, then the inexperienced can quickly find themselves in trouble.
And it doesn’t take years of experience to see that going into the financial markets is likely to be very challenging for at least the next year.