The inflation shock: strategies and support for asset owners and managers

Access to cross-asset and cross-border capabilities, along with trusted service partners, can help protect institutional portfolios in a fast-moving inflationary environment.

Suddenly we are living in an inflationary world. The post-pandemic economy is already beset by volatile demand and disrupted supply. Now higher inflation in commodities and energy combined with rising interest rates is challenging long-standing asset allocation strategies.

For institutional investors with large fixed income exposures, it is time to rethink and rebuild investment strategies. At BNP Paribas Securities Services, we serve as a partner to investors who need to sharpen their inflation-hedging reflexes, or who need to outsource execution of inflation-linked strategies for better risk management. 

We understand that fixed income investors now need a full suite of services to protect against the impacts of current and future inflation, including risk analysis, analytical data to help refresh strategy and practical market-oriented operational support. As many asset managers and asset owners know only too well, inflation can have a corrosive effect on unhedged portfolios by undermining the value of debt-based securities, so it is now time to re-orient and rebalance to mitigate inflation risk. 

Understanding and mitigating risks

Investors need to take into account how emerging inflation risks impact their portfolios – and for many accustomed to more than a decade of low rates and rock-bottom inflation, such inflation effects may be unfamiliar. As a securities servicing partner, we support clients who need analytics to protect their assets and returns as the inflationary temperature rises.

“For institutional investors, such as insurers and pension funds, who may hold half or more of their portfolios in fixed income products, the risks are particularly acute because their mandates limit options for diversification. We believe these institutional investors need new insights into their risk and mitigation options. Rich data and forward-looking analytics can identify optimal inflation hedging strategies, appropriate to their risk appetite,

commented Vera Delvoye, Asset Owners Strategy Lead at BNP Paribas Securities Services.

Inflation risk can be tamed by understanding. The first order of business is to identify and fill data gaps, thereby ensuring that asset managers and asset owners have a clear window on emerging inflation pressures in the real economy and their likely effects on financial markets. Cost inflation, supply-chain interruptions and volatile risk premiums are all interacting in the global economy to compromise fixed income returns. Responses call for insights based on data rather than instinct.

With data to hand, investors can identify underperforming investments, improve returns on idle assets and optimise short-term cash management through efficient access to the relevant capital markets, while increasing awareness of the impact of inflation on vulnerable assets. 

Seeking the best operational support

Inflation also increases operational challenges. Asset owners need to find the best collateral counterparties to reduce credit risk and locate securities lending partners who can support derivatives strategies. This is especially true in today’s investing environment where complex derivatives markets have high regulatory and compliance requirements, and where many asset managers and asset owners need to meet liquidity and solvency obligations that have become more stringent over the past decade.

Diversification is one way to manage persistent inflation. Investors need access both to higher yielding financial instruments and to global markets. BNP Paribas Securities Services has true global currency coverage to help support the cross-border diversification strategies that assume greater importance in an inflationary world. It is able to leverage an extensive global network to anticipate and manage the volatile credit risks that accompany derivatives and higher yielding instruments.

Changing strategies

As institutional investors adjust to medium and possibly long-term inflation that will depress returns on traditional institutional assets, such as US Treasury Bills and high-rated corporate debt, they need the tools to refresh and rebuild their top-down investment strategies. BNP Paribas Securities Services helps execute global diversification strategies, so they can continue to rebalance portfolios using short-duration or alternative fixed income products. These may include spread-based products like deposits, guaranteed investment products and derivatives such as standardised traded options and futures, as well as over-the-counter swaps that demand strong counterparty support.

Asset managers, insurers, pension funds or official institutions will also need greater insight into inflation-linked strategies and assets such as real estate and commodities that keep their value when prices are rising.

Confronting uncertainty

Investors are facing rapid change following a period of relative stability and inflationary effects are continuing to emerge throughout the global economy. Greater uncertainty and higher risk go hand-in-hand in this inflationary era – but the right partners can help manage and control this.

We don’t know how far inflation will rise, nor how long the surge will last. We do not know exactly how global monetary policy-makers will react. This uncertainty calls for comprehensive insight and real-time data, support for scenario planning and building innovative portfolios, all assisted by supportive partners with a broad global footprint.

As we have explained, operational risk is also much higher than before. Hedging against inflation has become operationally complex and its effectiveness depends upon the quality of partners. Owners of regulated institutional assets have little room for manoeuvre and yet events are moving fast. At BNP Paribas Securities Services, we have the capabilities and experience to minimise those risks – and maximise opportunity at the same time.