091 | Inflation: The Good, Bad and the Ugly

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  • Jonathan Baltora, Senior Portfolio Manager, AXA World Funds Global Inflation Short Duration Bonds, AXA Investment Managers

Learning outcomes:

  1. Definition of inflation and its different forms
  2. What happens during differing periods of inflation and the effect on various asset classes
  3. What can be used to offset the effects of inflation for portfolios


Learning outcomes: 1. Definition of inflation and its different forms 2. What happens during differing periods of inflation and the effect on various asset classes 3. What can be used to offset the effects of inflation for portfolios PRESENTER: Jonathan, begin by giving us what might be termed a good working definition of the term inflation? JONATHAN BALTORA: Inflation is the change in prices of a given period. So you can look at inflation on a monthly basis. You can look at inflation on an annual basis. Annual basis is the number, is the rate of inflation that is the most reported, most widely reported. And there are different measures of inflation. You can look at producer price inflation; you can look GDP deflator; you can look at consumer price inflation. So depending on what you’re looking at, there are different indices of inflation, different ways to report inflation, but the simplest way to put it is that inflation is the change in prices in a given economy. PRESENTER: So, who decides what inflation is? JONATHAN BALTORA: Your statistical agency. They are making choices in terms of reporting inflation. Just to give examples, you have what they call owner equivalent rents in the US. So basically that’s rents that are included in the CPI, consumer price index in the US. And that doesn’t exist in the euro area, so there are some choices that are made and just do with it, because the statistical agency makes their choices and this is it. PRESENTER: But it’s important to work out from someone’s point of view what goes into that basket that the statistical agency chooses to create their measure of inflation with, is it not? I mean over here in the UK we have CPI (Consumer Price Index), CPIH (Consumer Price Index including owner occupiers’ housing costs) now, including a measure of housing, and RPI (Retail Prices Index). What’s the right one to use? JONATHAN BALTORA: It depends what you’re trying to do. If you’re actually saying what inflation is, if you’re say the Bank of England, the Bank of England is going to use CPI, and they’re going to look at core CPI, which is a measure of CPI not including food and oil. PRESENTER: Consumer Price Index? JONATHAN BALTORA: Consumer Price Index. There’s another one which is RPI, and if you’re managing inflation in bonds, you want to look at RPI, because there are no bonds-linked to CPI, and UK linker, they are linked to RPI. So what really matters is RPI. So, depending on what you’re trying to achieve and what you’re trying to do with that inflation metric, you’re going to look at different indices. In the end the measures remain the same. So last year 2016, beginning of 2017, when inflation is accelerating all measures of inflation are accelerating in the same way. So they’re all going up. So in the end it’s not that big a difference but there are some statistical decisions that are made and that will impact the level of inflation. PRESENTER: How can people best visualise the impact of inflation? JONATHAN BALTORA: I think the best way to present that is that if you look at a 2 to 2.5% inflation rate. I mean it may not be, it may not look super-elevated, but that’s exactly the average rate of inflation in the US since the year 2000, and so people say OK that’s not a big rate of inflation. But that’s exactly the same on a compounded basis as saying that prices have increased more than 40% since the year 2000 in the US. So what really matters is not so much the rate of inflation, even if it’s relatively contained, is the compounding factor of inflation that will potentially erode the purchase power of consumers. PRESENTER: But one measure shocks more people than the other: 40% rise in prices over that period compared to 2½% per annum on an index. One is obviously more shocking than the other? JONATHAN BALTORA: Yes. PRESENTER: So it’s important to work out what it is that you want to do with this index when you’re choosing the one that you want to measure your investment against. Is that it? JONATHAN BALTORA: Absolutely. And if you’re a pension fund, then you have liabilities index to CPI or a liabilities index to RPI, and that will depend, I mean largely impact the asset and liability management that you will need to do. Again in the end when inflation goes up for CPI, it goes up for CPIH and also up for RPI. If you have revenues that are indexed to inflation, I mean the indexation process may not be exactly the same, or it may not result in the same increase into your pension or wages, but direction of inflation essentially remains the same. PRESENTER: I detect you’re saying it really doesn’t matter as long as you measure inflation? JONATHAN BALTORA: As long as your index is protected against inflation. PRESENTER: Now, I want to talk a little bit about the fear of inflation, because certainly it seems that central banks and central bankers have been guided by this fear of inflation, really since the 1970s. What happened then and what do you think is behind the decisions that the central bankers have made since then? JONATHAN BALTORA: There has been some significant changes in terms of the framework for monetary policy. If you look back into the ‘70s, what happened, it was definitely the oil crisis, so originating with what happened in the Middle East, but what was interesting is that it was protracted inflation, so self-fulfilling inflation: inflation shocks that were not managed, where central banks did not respond to those shocks. So with Alan Greenspan and Bob Walker to some extent as well, central bankers realised that if they did nothing inflation would keep rising because people’s expectations of future inflation would be attracting inflation even higher and higher again and again. So central bankers in the ‘80s, in the ‘90s introduced the concept of inflation targeting, trying to achieve a stable level of inflation and then they started to raise interest rates, to hike interest rates when inflation is accelerating, to try to control it. It worked very well for a time in the ‘90s in the beginning of 2000s, but then if you factor in the fact that we have globalisation and we had these inflation pressures coming from outside, especially basically from imported goods, Imported goods prices have been pulling down inflation across advanced economies, then it started to be a bit more complex for central bankers, especially in the face of the crisis in 2008, sovereign crisis in the Euro area 2010 and we’re still in the middle of that. And given the Japanese experience since the beginning of the year 2000, the fear is not so much inflation anymore. Especially that’s even more true in the context of high debt. People, I mean central bankers and the treasury would like to see high inflation that would erode the value of the GDP so that they’d probably be happy with it. So the fear is not so much inflation any more, the fear is deflation, and you can tell by all the measures that have bene taken by central bankers since basically 2010, they’ve been very active with, I mean the greatest scene of financial innovation has been happening with central banks and the new measures that they’ve been implementing to fight deflation, not so much inflation. PRESENTER: So, looking further back in history, are there any lessons that are pertinent to where we are today? JONATHAN BALTORA: To where we are today? The number one lesson to me is Japan. If you look at Japan, inflation has never been recovering because they realised only too late that they had a problem with the banking sector, and they were very slow to address it. And I think that the lesson from Japan is that when you identify a problem you need to solve it. That’s the, the economy called the Swedish example. When Sweden had in the 1980s, 1990s, sorry, a banking crisis, they were very, very fast to sort it out, to help the economy recover. To some extent that’s a bit of a difference between Italy and Spain today. Spain was very quick, they were under pressure to do that, but they were very quick to try to solve the bank situation, whilst it’s taking more time in Italy. So the situation is probably a little bit more complex right now. So the number one lesson is that when you see a situation where deflation can occur, you need as a central banker to be acting very swiftly, very quickly to solve the situation; to not let deflation spiral have a chance to start. PRESENTER: You’re beginning to sound as if a small amount of inflation is perhaps a good thing. I want to come on to that a little bit later, but ask you what’s meant by core inflation versus headline inflation, because we’re still talking about measures that people can understand here? JONATHAN BALTORA: If you’re talking about CPI, CPIH, RPI, that’s another term of jargon. Core inflation is the same as overall inflation that we call headline inflation but excluding the contributions from food and oil prices that are the most volatile components in the basket of goods. So that’s as simple as that. The reason why economists like to look at core inflation instead of headline inflation is because it tends to be more sticky; it’s less volatile. To give you an illustration, oil, you don’t consume oil; you consume gasoline. Maybe you can consume oil but not many people consume oil. And it’s something like less than 10% of the basket, but that’s something like 80% of the volatility of inflation. So that’s why economists have introduced the concept of core inflation, it’s more sticky, takes more time to move. It’s also a better representation of the actual pressures in the economy. PRESENTER: Tell me a little bit about demand-pull versus cost-push inflation? JONATHAN BALTORA: So to start with cost-push. Imagine you’re selling gasoline, if the price of oil increases then the price of gasoline is going to increase. It’s the same for, that’s the simplest example, but it’s the same for goods. Currently we’re seeing producer prices increases in China because commodity prices have been increasing and those prices are the prices for the goods that we will import. So we expect the prices of goods to increase, because the inputs in the production process have a higher price, you should expect the goods to the higher price as well. So that’s cost-push inflation. Demand-pull inflation can happen in some instances. In the world of globalisation, in the globalised economy that has been less the case, but that can happen, for instance if you look at housing. I think one of the best examples of the recent past has been the US. You have the poorest part of the population in the US that cannot afford to buy anymore because they have too low credit scores, and they are renting and the price for rent is going up, and this is pushing up inflation for residential housing in the US. So that’s demand-pull inflation. You can see that in services, in our experience not so much in goods, because goods are very dependent in the globalised economy that we live in, definitely working for services. PRESENTER: What happens in a deflationary environment? How do people recognise that they’re in a deflationary environment? JONATHAN BALTORA: Deflation, I mean the economy’s definition of deflation is when the overall rate of inflation is negative. It tends to be very, very rare. Even in Japan they had some periods of deflation, some periods of zero percent inflation – which is not exactly deflation, it’s basically prices stagnating. But the key economic consequence of deflation is that if you need to buy a car, it’s a lot of money and you know that prices are going down. So you don’t buy the car today, you’re going to wait for the price to decrease and you’re going to buy at a later date, and that’s bad for the economy because if nobody buys then prices fall. And because prices fall, people say hmm it’s going to be cheaper tomorrow so I’m not going to buy today. And that’s the ugly about deflation. PRESENTER: OK but there are certain things that create deflationary trends aren’t there? The internet, for example, that was an element that was brought in that caused prices to fall. Robotics is another trend that people are talking about now. And China even, they’re all part of deflationary trends aren’t they? JONATHAN BALTORA: There are some positive things for inflation; there are some negative things for inflation. If you break down the inflation, you can break it down into two, three categories. Food and oil, so that’s basically items that are prices in the open market, so you have very little impact of technology on that. You have goods and services. So goods have been very much under pressure of globalisation: basically, cheap labour from abroad and cheap imports. And services, services are pretty hard to outsource from foreign countries. So if you look at services inflation, health care inflation is one of the biggest components, housing, financial services etc.So those would probably be under pressure because of technology, but you also see that this is where inflation is the strongest. So on the one hand you may face some competition from the internet in those categories, but on the other hand we’re probably, and I think that Brexit vote and the election of Donald Trump are basically votes against wild globalisation of the economy. So we may see some things emerge that will very support the price of goods. So as always there’s a balance. Some items will see their prices falling, but not necessarily everything. It’s the story of Schumpeter, the story of creative destruction. So I’m not worried that we’ll enter a period of inflation because of robotics. I think it’s, I mean definitely some prices will fall because of that or thanks to that but I’m not sure we’re entering deflation because of that. PRESENTER: A little while ago, in fact not so long ago, there was a fear about stagflation. How would define stagflation and tell us why it’s been one of those things that the central bankers have really, really tried to avoid? JONATHAN BALTORA: Stagflation is bad because it’s an environment where you have prices rising - that’s inflation - and at the same time the economy is not growing. So you’re basically getting poorer and that’s simply bad. So that’s a definition of stagflation. In practice, inflation is very much related to economic activity. So it’s quite rare that you can have stagflation for a long period of time. If your economy’s doing well then inflation’s going to accelerate; if your economy’s doing poorly then there’s a good chance that inflation will slow down. So it can be some periods of transition. I can remember 2011, 2012 in the US, their growth was not very strong, inflation was accelerating because of oil prices, so you can have some transition years, or some transition periods where you have something that looks like stagflation. But that’s not five years, ten years of stagflation. If your economy’s not doing well, you will not have inflation; if your economy is doing better than you will have more inflation. PRESENTER: So in a sense you’re saying that a little inflation is a good thing. So I’m going to press you, how much is a good thing? JONATHAN BALTORA: How much is a good thing? PRESENTER: Define a little inflation being a good thing, rather than the bad thing or the ugly thing that we sometimes thing of inflation as? JONATHAN BALTORA: Economist’s definition of good inflation is stable prices. So in theory this would be zero. But the problem is if you have a target of zero percent inflation, as soon as you get the bad news then you’re in deflation and that can be a disaster, and that’s the situation that everyone wants to avoid. So there was a consensus among central bankers to use a common rate of inflation of say 2%, which is close to zero but not zero, and so that’s the reason why central bankers have been targeting 2%. But there are some others that believe that central banks should tolerate more inflation. So the former head of the IMF, Olivier Blanchard, had advocated, back in the days, for 4% inflation target. So it may change in the future. It’s arguably we could say that economies with high debt GDP ratios would need more inflation than those with low debt GDP ratios. So it’s really a matter of investors’ expectations and trying to not surprise the markets too much, because if you change your inflation target then you risk starting some volatility in interest rates. So it’s really a matter of being transparent, predicative, which is really what central banks are trying to do. PRESENTER: You know that in the UK if inflation goes over 2% the Governor of the Bank of England has to write a letter - how archaic is that? - to the Government to explain why and what they’re doing about it. That’s that 2% again. JONATHAN BALTORA: I think the Bank of England was one of the first central banks to start with inflation targeting. So I’m not surprised. I mean even Mario Draghi who is the head of the ECB would need to go through the parliament and would need to explain. So it’s one of the little things you like about the UK, it’s really nice. I don’t think it’s a problem. PRESENTER: Is the UK susceptible to more inflation than other countries in the world? JONATHAN BALTORA: I think so. I think when you look at advanced economies globally their inflation rates are very correlated. So in 2016/2017 when you see inflation accelerating, it’s the case in the US, it’s the case in the UK, and it’s also the case in the Euro area which was under pressure for potentially falling into deflation. At least it was one of the fears of investors. And in the end when you compare it across countries, there’s one source of inflation which is the currency. If your currency depreciates then you’re susceptible to see more inflation in your economy. And the UK is very much exposed to that. Across advanced economies it’s probably twice as sensitive to imported inflation through the currency compared to the US or the Euro area. PRESENTER: Let’s now turn to inflation from an investor’s point of view. Explain what a positive real yield is, and what’s the impact of inflation on various asset classes? JONATHAN BALTORA: So the positive real yield is when the yield in the bonds, or the assets you own, are superior to inflation. So if you have 2% inflation but the yields of your asset is 3%, you have a positive real yield. Meaning that your assets will not erode because of inflation, you’re making more money. You’re earning more money than inflation. From an investor perspective, the current environment is interesting, because if you look at nominal bond yields, you will have, you will see that very often nominal bond yields are below the rate of inflation. To us, it’s a good case for considering inflation in bonds or inflation protection strategies. So, depending on an asset class basis, the impact of inflation is different. It’s very mixed for equities depending on what sector you’re looking at. So if you’re looking at the energy sector and those sectors have a pricing power in general, that’s pretty good for those equities. Those equities that don’t have a pricing power vis-à-vis their consumers, it tends to be that. That’s the first segment of… PRESENTER: So you were saying in terms of higher inflation those sectors that have pricing power are better to be invested in during those periods? JONATHAN BALTORA: Absolutely. In general inflation is bad for bonds – because if inflation moves higher than interest rates, investors will demand more for lending money. So that’s the general rule and that’s what you’ve seen with the election of Donald Trump and rising oil prices. Inflation was accelerating, expectations of future inflation were also picking up and as a result interest rates increased in the US. So that’s a good example of why inflation can hurt bonds. I’m talking about fixed rate bonds, not the inflation-linked bonds. PRESENTER: Explain to me then what you mean by inflation-linked bonds, because it would seem illogical to be in fixed rate bonds when there is a period potentially of inflation rather than in inflation-linked bonds. JONATHAN BALTORA: If you’re in a period of inflation and the yield you earn in those fixed rate bonds are higher than inflation, it’s not necessarily a bad decision. If the yield in the nominal gilt market or the nominal bond market are below the rate of inflation then you may need to consider some other solutions. So an inflation-linked bond, is what is also called in some other markets, it’s also called a real return bond, meaning that your cashflows and the redemption at maturity, so that’s the coupons and the redemption are fully indexed to inflation. So your annual or semi-annual true coupon will be indexed to inflation, and to me the key benefit is that it’s not only the income that is protected against inflation, it’s also the final payment, so the value of your capital that is indexed to inflation and protected against inflation. That’s in a simple way an inflation-linked bond. PRESENTER: So here’s a very important question, by what measure of inflation should people judge or view inflation-linked bonds? JONATHAN BALTORA: You should look at the measure of inflation to which they are indexed to. So in the UK we’ve been talking about CPI, CPIH and RPI, they are indexed to RPI. So what investors are looking at is RPI, because this is what drew them in the index which they are indexed to. I think an important thing to mention is that when you’re buying inflation-linked bonds, that’s the case across the globe in advanced and emerging economies, you are indexed to overall inflation, the inflation rates that include food and oil prices, which in my view is a good thing. PRESENTER: So how can people use index-linked bonds as part of a diversified portfolio? JONATHAN BALTORA: It really depends what is your investment horizon and who you are as an investor. If you are an insurance company or a pension fund, you want to hedge against inflation and you want to hedge against interest rates because you have a duration in your balance sheet and you need to hedge it. So you would go for the longest maturities on the curve that have the benefit of having a long duration and high sensitivity to interest rates, but also being full indexed to inflation. So that’s the benefit for those investors that have a long-term investment or long-term liabilities. If your clients are more retail, if you’re an adviser for instance, you may just want to have the value of your cash indexed to inflation. So you may decide to allocate to shorter maturities in the market that are less sensitive to interest rates but on the balance their indexed to the same rate of inflation. So the shortest maturities on the curve may be more suitable for retail investors and advisers. PRESENTER: If you were an adviser, Jonathan, how would you explain the concept of duration to a retail client who may not have come across it before? JONATHAN BALTORA: So the concept of duration is the sensitivity to interest rates. The longer your bond investment with a fixed rate, the higher sensitive they are to changes in interest rates. Because the stream of coupon is very long, you have many coupons that you need to readjust depending on interest rates going up or down, so the concept of duration is basically based on the average maturity of your bond holdings. You have more uncertainty for longer maturities. So you have a longer duration for longer bond holdings with a fixed rate, while it’s the opposite for shorter maturities. Shorter maturities have more predictability, maybe, so lower duration. PRESENTER: Since 2008 we seem to have had a period of low rate and relatively low inflation. What makes you think that this is going to change in any way, shape or form? It was called low, low and slow. JONATHAN BALTORA: Low, low and slow. I think that the key idea is essentially the level of inflation compared to the level of interest rates. And our scenario is that inflation is normalising. We’re not saying that we’re entering a period of super high inflation, that’s not our scenario; we’re just saying inflation is normalising and we are seeing risk to the upside when we look at the balance of risks. Basically politics, the resistance against globalisation, so free trade is potentially in danger and that could increase the price of goods. In the US, under the Donald Trump presidency, there are some other risks. The health care reform is likely to boost healthcare inflation. Obamacare, so the affordable care act in the US, had pushed US inflation for healthcare from something like 6-7% annually down to something like 1-2% annually in 2013, so if you repeal and replace Obamacare with something else, some households may lose protection, but that could also boost prices for healthcare. We believe that there are some other risks to the outlook and they are to the upside, essentially coming from China. They are second run effects, rising commodity prices being translated in higher production costs for producers of goods. And if you look the producer prices in China, they were negative a year ago and now they are very positive, and we believe that this will be translated into higher inflation. And then there’s also probably one last topic that is probably overlooked which is fiscal austerity. Between 2012 and 2014 inflation kept disappointing because countries were doing fiscal austerity, so basically less demand from the state, and today it’s quite the opposite. So there’s been, it looks like there’s been a change of mind and now we actually find that we have fiscal multipliers. So when the state spends money it’s good for the economy it creates more growth. So all countries for instance in the Euro area are now in positive growth and they’re running budget deficits and everybody closing their eyes, and this is good for growth and this is in turn good for inflation, so another risk to the upside. So, to conclude on that outlook for inflation, we’re talking about normalisation. So our outlook for this year is 2.5% inflation in the US, 1.5% in the Euro area and a bit more than 3% in the UK because of the impact of the currency depreciation and the path through. PRESENTER: That may well feel like a good thing to the people of the UK and US? JONATHAN BALTORA: The rebound of inflation? PRESENTER: Yeah. JONATHAN BALTORA: I think so. I mean deflation is my worst nightmare, so a little bit of inflation close to target is very good. PRESENTER: OK, so if people take a view and agree with you on the outlook inflation then they should be perhaps considering inflation-linked bonds. How do you believe those may perform and what should people look at in terms of performance of inflation-linked bonds? JONATHAN BALTORA: The number one consideration is the investment reason. For how many years are you investing? The longer you investment is in, the longer the maturity of your inflation-linked bond holdings. I think it’s the number one priority, because inflation-linked bonds, if they have a long maturity they’re exposed to interest rates. And that’s the trick. If you invest for the short term, if you buy long-term inflation-linked bonds, then you will be influenced in changes in interest rates and you may get some good or bad surprises. If you invest for short-term investments, in the shorter-term investment horizon, then shorter duration inflation-linked bonds would make it. I think it’s really a matter of your investment or reason for how long will you be in the market. The longer you will be in the market, the longer the maturities on the curve are probably better suited for you. PRESENTER: The question that comes up occasionally when talking to potential investors is what’s the difference between inflation-linked bond and a floater, and a floater I presume is floating rate bond? JONATHAN BALTORA: A floater will be bond indexed to a money market rate, so indexed to Libor for instance. And people tend to compare the two bond structures because they feel like if inflation accelerates interest rates will need to go up. So they say well maybe floaters are going to make it instead of inflationary bonds. That sounds legitimate but I think personally it’s wrong, because for floaters to compensate for inflation it means that the central bank needs to tighten major policy and hike money market rates when inflation accelerates. It may have been the case in the past but it’s not so much a case again. If you look at the UK, the Bank of England is unlikely to react to the current inflation rate, so you will have more than 3% inflation but Libor is going to remain close to the same level. So maybe floaters could be good to reduce your sensitivity to duration, to interest rates, because floaters have now duration. But on the other hand the income from those bonds, unless the central banks very aggressively tighten the monetary policy, it’s not going to compensate for inflation. So this is why in an environment of accelerating inflation, it’s probably good to reduce the maturity of the bond holdings, reduce the sensitivity to interest rates, but inflationary tends to be explicit inflation indexation, will probably in my view outperform floaters unless the central bank very aggressively tightens its monetary policy. PRESENTER: Finally, then, Jonathan, in your view and your experience, how do different types of investors use inflation-linked bonds in their portfolios? JONATHAN BALTORA: I would say that there are some key considerations when you’re looking at inflation-linked bonds. You can look at local inflation link bonds or you can look at global inflation-linked bonds, and we’re definitely seeing a shift towards global inflation-linked bonds, because of the need to diversify sovereign risks. And also the acknowledgment that inflation is a global phenomenon. Across advanced economies something like 70-80% of any local inflation rate is the result of global inflation. It’s just that the price of goods and services are very comparable across advanced economies. So the inflation dynamic globally is the same and on top of that you can diversify the source of inflation indexation because it’s essentially a government bond market: very few corporate issuers. And then as a result of shift towards what’s global, and what we also see is that the investors, like pension funds and insurance companies, they’re very much interested by the longer maturities on the curve. That’s just based on the fact that they have super long investment horizons, and they need the long duration, but for more, for the advisory business and private banking and individuals, we see a shift towards shorter maturities on the curve, simply based on one fact. If you buy one year or 50 year, UK linker, for instance, then you earn the same rate of inflation. So if you invest because you need the duration in your pension fund, the 50-year or 30-year aren’t going to make it. But if you’re an individual and you want to protect the value of your assets against inflation, maybe it’s better to be at the front end of the curve reducing the duration and just trying to get maturity income. PRESENTER: Talk a little bit about liquidity where inflation-linked bonds are concerned. JONATHAN BALTORA: So liquidity is an interesting topic because it’s a bit of a paradox in the inflation-linked bond market. When you listen to market makers, brokers, they will complain about liquidity. That’s probably also to some extent trying to extract from you a bit more premium, but we’ve been investing a lot in big data analytics with our trading desk, and we’ve been analysing the market, also looking at official data. And to take the US inflation bond market for instance, the key change that has happened over the past five years is the ban on proprietary type trading. So for some it was bad because it was kind of a witch hunt going in the market, but still if you look at volumes, and that’s official volumes for New York Federal Reserve, 2016 was the highest on record. So people complain about liquidity on one hand but then on the other hand volumes traded were the highest record, which is interesting. So we did a bit of research. We dig a little bit around that, and we found liquidity and volumes tend to become more concentrated in some bonds that are the benchmark bonds, the mostly recently issued one, which is also the reason why we believe that there’s more value in active management of inflation-linked bonds. If you do passive, in our view you will overexpose your portfolios to the largest bonds which are the oldest ones and the least liquid bonds. While in our actively managed portfolios which we’re doing is that we are overexposing the portfolio to the newest bond the most recently issued one where most of the activities taking place, and that’s something that we’ve identified together with our trading desk using those analytics that they have developed. PRESENTER: So how often do you trade in your fund? JONATHAN BALTORA: So you can trade for various set of reasons: in and out flows of course but also when you want to reposition a portfolio. There can be weeks when we don’t trade because we believe that we have the right position. Our investment philosophy is not to do micro relative value trade, very, very capital intensive; we’re more doing asset allocation. I mean the secret of actively managing an inflation-linked bond portfolio is that when you see inflation accelerating you absolutely want inflation-linked bonds and you want to reduce the maturity because you want to reduce the exposure to interest rates as rising inflation as historically that’s associated with rising interest rates. On the other hand, when you see inflation falling, that can happen, and you want to extend the maturities in your portfolio and you want to potentially have nominal bonds, so nominal gilts or treasuries or potentially bonds as well, just to reduce the sensitivity to inflation. So that’s how we view the market, an inflation-linked bond is a trade-off between inflation and duration. Rising inflation, you need the frontend of the curve, the shortest maturities. Falling inflation you want to extend maturities and potentially add nominal bonds to the portfolio to prevent a negative impact maturing from falling inflation. PRESENTER: So how do you use your view of inflation in managing portfolios? JONATHAN BALTORA: So take for instance the AXA Global Inflation Short Duration Bonds Fund. You can see that as a trade-off between inflation and duration, because it has such a short maturity focus on the curve with maturities going up to five years, and what you will find is that when inflation is accelerating or when we expect inflation to accelerate based on our analysis, we would prefer the frontend of the curve because historically the longer maturities tend to be less positively affected by rising inflation, there’s a risk that duration and rising interest rates will push their bond yields higher which will be negative. So rising inflation you want to buy the frontend of the curve. In the opposite scenario where we see inflation decelerating or even if we see the market as expensive, what we can do is potentially shifting the assets from inflation-linked bonds into nominal bonds. I mean I’m not talking credit or the asset classes, I’m just saying in the sovereign space, so potentially selling UK gilts or US tips that are both linked to inflation into nominal bonds, so gilts, treasuries or potentially bunds, just because falling inflation will be potentially negative for the income of those bonds. And the other thing we can do when inflation is accelerating is that we would potentially extend the maturity of our bond holdings simply because the frontend of the curve is the most exposed to inflation and falling inflation would not necessarily be very good for those, and falling inflation is also very often associated with falling interest rates, so probably better going longer on the curve. PRESENTER: On that note, Jonathan Baltora, thank you very much indeed. JONATHAN BALTORA: Thank you. Important information This communication is for investment professionals only and must not be relied upon by retail clients. Circulation must be restricted accordingly. 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