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Dealing with inflation on a fixed income

by David Campbell on Dec 27, 2012 at 07:00

Moving into short positions

For this reason, Puntillo has moved as much as 40% of net assets into short positions against leading Western sovereigns in the last month. As speculation about QE3 mounted in mid-August and mid-September, yields on the ‘safe haven’ sovereigns moved out by as much as 30%, although this has since tightened a little.

‘Some of these fat tails are now backed by central banks, and people are moving out as they realise the risks they are running,’ he says. ‘We are not looking to protect against inflation in the short term, but where we can find cheap protection against the future, over a 20 or 30-year horizon. Bernanke has made it clear now that he is basically prepared to keep on printing forever.’

To him, the problem of protecting against a foreseeable future of moderate inflation and a longer term horizon with little-to-no visibility on inflationary prospects is fairly simple.

‘We have added Israel and Poland [recently] at yields of around 10%,’ he says. ‘You are getting high real yields and very cheap inflation priced in.’ Up to 30% of the portfolio is currently invested in emerging market local currency debt.’

On the latter point, much depends on your expectations for global growth over the next 12 to 18 months, however.

Capital Economics, one of a very few forecasters to accurately call the sustained low in Treasury yields, has short-term yields pencilled in at a rate of 1.5% for the foreseeable future, on the back of continued global deleverage and structurally limited growth prospects.

The Macro Research Bureau (MRB), however – which has a much more bullish forecast for growth on expectations of a stimulus-led recovery in risk assets – believes the long-term trend has begun to break down decisively.

But both agree the market will remain volatile and continue to move with the pendulum swing of risk on and risk off.

‘While nominal yields have risen modestly in the past three months, real yields have drifted deeper into negative territory,’ noted MRB in recent guidance to clients.

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