John Atkin of M&G sets out more predictable inflation-matching alternatives to the ‘roller coast ride' of commodities.
Of course, properties are absolutely at risk of fluctuating in price-like equities or commodities, but prime long-lease property yields can be far superior to comparable index-linked gilts or index-linked corporate bonds.
In fact, our analysis has shown that under certain assumed economic conditions, some leases can earn more than comparable bonds even if the property price falls zero at the end of the lease term. Investors will generally receive protection against deflation too, as most rents revalue between 0 and 5% per annum.
Social housing debt is another example. As the banks deal with the implications of new regulations, and a need to shed assets, they have pulled away from offering loans to certain sectors of the UK economy. The UK's social housing sector is one that's been struggling to finance itself since the height of the financial crisis.
However, there is a political consensus that the UK needs more social housing and as far as credit quality is concerned, the sector is supported by strong regulation that has tended to focus on the economic health of the Housing Association Registered Providers (HARPs) who build and maintain social housing. To date, no lender to the sector has ever suffered a loss.
As an asset class, long-term social housing debt suits both pension funds and borrowers. We recently closed our first Social Housing Fund, which aims to return 2%-2.75% above LPI. Social housing debt also typically protects against deflation.
There are more examples, but I'll finish with a twist on the most obvious opportunity - the index-linked gilt, the seminal product that popularised inflation-linked assets worldwide.
With less than £300bn worth of index-linked gilts in existence, the assets stand little chance of hedging the trillions of pounds of inflation-linked liabilities by themselves.
As the most obvious opportunity, demand is rampant - made clear by the fact that at the time of writing, real yields on every index-linked gilt are currently below 0%. But while the market is expensive, active rather than passive management does unearth opportunities to earn greatly improved returns.
This is because over the last few years, the market has become more liquid and much more volatile. This may sound odd given everything I said about volatility earlier, but this volatility is inefficient and can be predictable.
An active manager can deploy several low-risk strategies to achieve impressive outperformance. For reference, our pooled index-linked gilt product has comfortably delivered over triple its 0.75% outperformance target in 2011, by managing 2.75% above its benchmark.
Finally, although index-linked gilts offer no deflation protection (although a manager may be able to allocate to conventional gilts, which tend to perform well during deflation), they are unique in that they promise completely unlimited inflation protection, even if we start needing trillion pound notes to pay for kit kats.
Also, while you sacrifice liquidity with the other investments, you don't with index-linked gilts. An allocation to an active fund is, we feel, a potentially useful weapon in every fund's arsenal.
I'll stop there, but there are more opportunities still, including infrastructure debt, ground rents and index-linked corporate bonds, and we're always on the lookout for more.
Pension fund investors need to be on the hunt for inflation protection that is explicit, contractual, safe and largely immune from the volatility of the wider market.
While these assets may not have the potential upside of commodities, they offer predictability and reliability, which should be attractive (if not fascinating) to pension funds in the current environment.
John Atkin is director of fixed income at M&G
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