Why Investors Should Do Everything Possible to Defend Against Inflation

KKR and J.P. Morgan Asset Management argue that it’s all about investing in assets with “pricing power stories” behind them.

Hollie Adams/Bloomberg

Hollie Adams/Bloomberg

Allocators need to prioritize inflation protection over the next 12 months.

In a report on global macro trends expected to be released on Thursday, the $471 billion private equity firm raised its U.S. CPI forecast above the general consensus, driven largely by the anticipated prices of energy and food. KKR’s 2022 CPI forecast for the U.S. is 7 percent, while its forecast for 2022 real GDP growth in the U.S. is 3.2 percent. As a comparison, Bloomberg’s 2022 inflation expectation is lower than KKR’s, at 6.1 percent, while its estimate for real GDP growth is higher than KKR’s, at 3.6 percent.

“Inflation erodes the purchasing power of a portfolio’s value, and it can be particularly detrimental to investors who rely on cash flows generated from fixed-income asset classes,” Jenny Yiu, head of inflation products for BNP Paribas Asset Management, told Institutional Investor in an e-mail. “Investors should consider incorporating inflation-sensitive asset classes into their allocations, such as real assets, as a [way] to improve a portfolio’s resilience against inflation risks.”

KKR agrees, saying that it will continue to focus on “pricing power stories,” with an emphasis on investments in infrastructure, real estate, and “asset-based finance areas.” KKR also said it prefers more growth in global equities and favors “opportunistic approaches to both traded and non-traded credit,” the report said. “Pricing power is really important,” Phil Camporeale, a portfolio manager at J.P. Morgan Asset Management, told II.

KKR also said that it recommends deploying capital to hedge against long rates to keep up with the anticipated “sticky inflation.” The company raised its 2022 target for the U.S. 10-year interest rate yield from 2.25 percent to 2.5 percent. From 2023 and beyond, KKR’s 10-year interest rate target remains at 2.75 percent.

“Reflecting the Fed’s near-term hawkishness (including our belief that it needs to shrink the balance sheet to cool the housing market), we raise our 2022 target for the U.S. 10-year yield to 2.50 percent from 2.25 percent previously,” the report said.

Camporeale said that JPMAM expects inflation to even out by the middle of 2022. While KKR has high expectations for inflation in the coming year, its inflation expectations for 2023 are much lower, coming in at 3 percent. This is still higher than Bloomberg’s 2023 inflation forecast of 2.6 percent.

While gross domestic product (GDP) grew in 2021, KKR expects a shift that will see inflation outweighing the positive effects of real growth. This inflationary environment, the report said, is happening amidst increasingly volatile economic conditions worldwide, including central bank tightening, ongoing supply chain disruptions, and liquidity withdrawals, not to mention the ongoing effects of the Covid-19 pandemic and the Russia-Ukraine conflict. For these reasons, KKR recommends that allocators do everything in their power to defend their portfolios against inflation.

“We continue to advocate that asset allocators prioritize inflation protection by overweighting collateral-based cash flows, including infrastructure, asset-based finance, and real estate,” the report said. “We also expect high cash flow conversion, private equity, and opportunistic credit to perform well.”

KKR also said it believes that investors should continue to shorten their duration in both public equities and global fixed income, and to overweight their strategies in liquid and illiquid markets. “Volatility, in our view, is creating real alpha opportunities,” the report said. “We are very bullish on opportunistic liquid credit, as well as flexible capital in the private markets that can deliver financial solutions to good companies with bad capital structures.”

KKR further recommended that, in addition to taking a defensive approach, investors should take a more thematic approach to investing. “Lean into high-conviction ideas and/or complexity, [including] energy transition/security, cyber, defense spending, digitalization, automation/logistics, and the rise of the global millennial.”