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Cash ain’t trash: Time for a rethink on CPI+ objectives

The previously (relatively) low hurdle of a CPI+ return objective is going to be harder to leap in the future. It might be time to return to the old stalwart of cash.

“CPI+ objectives are becoming increasingly difficult to achieve,” Damien Hennessy, head of asset allocation at Zenith (photo at top), said on Thursday (October 13). “But it also depends on the sort of investment regime you believe is going to hold over the next seven to ten years. Under our base case scenario, we think a typical portfolio but with some unlisted assets as well has a probability of meeting its CPI+4 objective of around 30-40 per cent.”

“… If indeed we move into a high inflation environment, and that’s one where inflation is closer to 3.5-4 per cent rather than 2.5-3 per cent, the likelihood of meeting that objective drifts down to something like 10-20 per cent.”

Those CPI+ return objectives worked perfectly well in a regime of tightly maintained low inflation of two to three per cent. Things are obviously different when inflation rises above trend and stays there for an extended period of time. And with inflation at around six per cent, generating a margin of five per cent above it is “a really high threshold to beat”.

“The way that we’ve started to think about these issues with managers is that… Maybe we need to start thinking about a cash or a cash+ benchmark as a different option,” said Andrew Yap, Zenith head of multi-asset allocation and fixed income. “Cash is investable; inflation is not. Cash represents the foundation upon which you can start to allocate capital and risk, and maybe that’s a better way forward for the industry.”

“It’s going to take some time for people to make that move, particularly as we start to see inflation ease and go back to 2-3 per cent. But it’s something I think is a trend that’s starting to rise in prominence across the domestic market.”

And the shockwaves roiling global markets aren’t going to disappear anytime soon, though Hennessy notes that equities and bonds have already adjusted quite significantly in line with recession expectations (though others in the unlisted space, like direct property, infrastructure, and private equity, are yet to).

“What hasn’t happened at this stage is the earnings side. We feel that in markets we’re now moving into the second phase of the bear market, where the focus turns from PE and starts to focus on the underlying growth and earnings side of the equation. It’s that one we feel is going to be under pressure over the next six months.”

“…I feel we’re on the cusp of that now. That will then come down to, if we do have a recession, how deep that recession is likely to be. There’s an argument that suggests (that after the GFC) a lot of changes were made to protect the banking system and the credit network more broadly; the banking system is in much better health and the balance sheets are better than they were 12 years ago. So there’s an argument that the recession that is being priced into markets is likely to be of the milder variety. That gives us confidence that there’s downside, but that it’s not significant at the moment.”

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