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Inflation and the Investment Industry

Good morning and Chris thank you for those kind words.  The theme for today’s conference is Next Generation Investments and so in my remarks I want to do a couple of things.  First, working with the Board of the IA, the executive team and Chris has been fascinating, stimulating and rewarding but with a refreshed board and the IA now very much at the heart of helping to shape the policy agenda for asset management and stewardship it’s time to look to the next generation.  As Chris has just revealed I have decided to step down in September and the search for my successor is well underway.   Second, I want to take this opportunity to give my perspective on the challenges facing the industry.  For the last ten years the democratisation of financial risk has been one of the biggest challenges facing the industry as individuals have to take more responsibility for their and their family’s financial future.  This has not gone away but will now be complicated by the momentous shocks of the last couple of years. The pandemic and the Russian Invasion of Ukraine have already changed the perspectives of markets, investors, consumers, policymakers, and politicians.  In my view the biggest challenge that we will have to deal with is a major shift in the return environment.  Over the course of a career that has spanned 43 years I’ve witnessed quite a few Investment cycles but only three different return regimes:   

The long bull market in asset prices from 1980 to 1999.  Second the search for yield and reach for risk, 1999 to 2007.  Finally, the low inflation, low interest, slow growth with compressed but volatile returns that characterised the post-crash world.    

The key driver behind a profound change in the return environment is the revival of inflation.  For those who have never experienced it, inflation is one of the most pernicious phenomena in economics. Persistent inflation erodes the value of money, destabilises asset markets, destroys wealth and disrupts the allocation of resource including turning savings into investment.  Persistent inflation also brings profound distributional challenges.  One of the key lessons of the 1970s was that inflation not only affects individuals in different ways but individuals themselves face differing inflation rates. Broadly, the poorest face higher inflation than the well off and therefore a much greater squeeze on their living standards.  The longer inflation persists the greater the squeeze and the bigger inequality issues become and the greater the risk that economic issues morph quickly into social issues.   

Why the references here and elsewhere to the 1970s?  A less well-known characteristic is that until the 1970s inflation was largely associated with wartime.   

Over the last 121 years, UK inflation averaged 3.7% but this was boosted by inflation of 19.4% in WW1, 7.2% in WW2 and 12.3% in the 1970s. Outside these periods’ inflation averaged a remarkably subdued 2.7%.  It was 0.5% in the first decade of the 20th century, crept up to 4.1% in the post war period up to the 1970’s and has fallen back to 2% throughout much of the 21st century.  The 1970s are the only episode of peacetime inflation we can learn lessons from and given its pernicious nature it’s incredibly important we do. 

One of the clearest messages is don’t let the inflation process get underway as it’s persistent inflation over time that does the damage so don’t allow inflation expectations to slip their anchor. I along with other economists have found it useful to distinguish between shock anchoring and level anchoring. Shock anchoring is how inflation expectations respond to supply side shocks; the general view has been that they have been fully “shock anchored” since the early 1980s. Level anchoring is a more gradual process where a fraction of changes in core inflation are passed through to inflation expectations.  That fraction is generally thought to have reduced over time until the point where inflation expectations were fully level anchored by the early part of this century. To bring this alive let me illustrate the mechanism with some highly stylised and over-simplified numbers.  By the mid-1980s, UK inflation had fallen back to around 4.5% and was inimical to supply side shocks.  It then took a further 20 to 25 years for inflation expectations to be ground down to the 2% level that most economists and central banks use as a proxy for price stability.  Inflation expectations moved at a glacial place dropping by 0.2/0.3% pa for 20 years before stabilising at 2% for the next 20 years.  Some might argue that the supply shock is largely the result of the war in Ukraine and with monetary policy founded on inflation targeting and independent central banks still in place any upward drift due to the level anchor slipping will also be glacially slow.  Inflation therefore is a temporary blip and a return to the norms for peacetime inflation is on the visible horizon. However, the impact of supply chain issues was having an impact pre the Russian invasion of Ukraine and inflation in the UK rose from 1% to 5% during 2021.  

So there are worrying signs, particularly in the UK that the shock anchor may be starting to slide.  One of the paradoxical effects of unanticipated inflation is that the demand for labour increases and unemployment continues to fall as the inflation process gets underway, and this is currently being exacerbated by the labour force shrinking due to early post pandemic retirements as well as Brexit. We have seen a massive increase in public debt as the government rightly chose to support private sector incomes during the pandemic to avoid a deep recession becoming a prolonged depression.  Any additional fiscal expansion will simply increase the burden of controlling inflation on monetary policy. While these technical issues can be resolved, the real concern must be the speed with which inflation is impacting on the public psyche. Within the space of a couple of months, the associated cost of living crisis is starting to dominate the political as well as economic agenda and we are starting to see a more aggressive stance from the trade unions.  Whether this triggers persistent inflation, time will tell but it’s worth noting that even a return to pre financial crisis norms will leave Inflation playing a more important role in the return environment than at any point in the last generation. Looking back to our averages, before the 1970s inflation averages around 4%. Between1980 and 1999 it was closer to 6%.  If Inflation were to stabilise at 5%, half the expected peak, it would still erode fully the value of money after 15 years.   

One of the key hallmarks of a mature industry is that it becomes more commoditised, growth is more difficult to come by so market share starts to be the driving force of growth and that generates consolidation.  Brand becomes very important and gaining the trust and confidence of the end customer is critical for business success.  In our business, every now and again, we get a timely reminder that investment performance is our number one job and I believe that the changing return environment and revival of inflation are generating one of those moments.  If we look back at the three big return regimes, they are periods dominated by very different investment brands and products and business models.   

To survive many had to adapt, some didn’t and disappeared but to thrive the successful delivered investment performance for their clients and end customers.  Delivering investment performance that beats inflation is a critical part of this.  Again, returning to our three return regimes look at the difference over these periods of what has been delivered to the end customer. Returns have been reduced and compressed and given the significant increase in the volatility of risk premia are arguably more costly to deliver.  One of the biggest challenges still facing the next generation is the delivery of a simple, scalable, investment return that beats inflation and is also easy to understand and cheap to deliver.  

One of the reasons this is a pressing need is the distributional impact of inflation. On a look through basis, UK households are split between 44% housing, 36% fixed income and only 20% equity in 2018.  However, its mainly the wealthiest 10% that own the riskier assets.  Between 1980 and 2018 with little access to meaningful capital gains in risky assets, the wealth share of the bottom half of the population has declined substantially. If inflation returns in any meaningful way this is a trend that will accelerate.   

One area where expectations are very high is stewardship, where I think we’ve made a very strong start but there is a huge amount to do. My plea is simply to put stewardship and engagement where it belongs as an integral part of the investment process. This aligns it with investment decision making, rather than with product and helps avoid the box ticking and greenwashing allegations that inevitably follow. 

No shortage of challenges for the next generation and our central task of delivering investment returns that help transform savings into investment has become more complicated given the economic and political environment we are dealing with.  The good news is over the last couple of the years the IA is increasingly helping shape the agenda.  However, the glare of the spotlight on the industry has never been more intense.  In our engagement with policymakers and regulators the IA must look to cut through all this complexity and be a strong voice for the industry, its customers and clients and its competitiveness. Not least because if we get it right and the rewards are significant. Let’s not forget the dire 1970s were followed by two decades of strong growth and investment returns. The next couple of years will be tough, but we also know that recessions not created by a banking crisis tend to be followed by robust recoveries and strong asset returns, providing inflation is kept under control.  The real challenge for the next generation is not just to help make it happen but also ensure the benefits are more widely felt. 


UK Total Real Returns 1980-2019 

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Source Barclays Equity Gilt Study 2019 



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Source Bank Of England Inflation calculator 












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